What is Rental Parity? What features or characteristics create value above rental cashflow value?
Asking Price: $1,425,000
Address: 34 Coldbrook Irvine, CA 92604
{book1}
I’m solid gold
I’ve got the goods
They stand when I walk
Through the neighborhoods
Makin’ It — David Naughton
The concept of Rental Parity is often discussed on this blog, but to date, I have never devoted a post to defining it and explaining it before today.
I first discussed Rental Parity in How Inflated are House Prices?, and later I added Rent Versus Own to explore the cost of ownership and relate it to the cost of rental. Finally, I added a subjective refinement to the rental parity basis in I Will Not Call a Bottom.
What is Rental Parity?
Rental Parity is a mathematical relationship between rental rates and property values where rent is equal to the monthly cost of ownership. There are many assumptions and variables that impact Rental Parity — so many that it takes a spreadsheet to try to explain it. (We have a calculator that provides the total cost of ownership on a monthly basis to compare
to the cost of renting. What is perhaps more useful to buyers is the
ability to run the calculation in reverse — If you know what you spend
on rent, you can estimate how much house you can afford.)
The fluid relationship between rents and prices provides a conceptual understanding of value. Rental rates establish where property values should be. Rental Parity is a balance point where there is no financial advantage to choosing renting or owning; a point of theoretical indifference.
If we had a group of theoretically indifferent people who always acted rationally based on perfect information, prices would always be at Rental Parity; any price below rental parity would be perceived a bargain and bid upward, and any price above rental parity would be perceived as too high, and there would be no bid interest. Of course, we all know that people are not indifferent; in fact, they can become very emotional about buying and selling real estate. When they participate in a market, they get caught up with the herd and move prices without regard to fundamentals; short-term price movements become accepted as the market’s long-term trajectory. Trees really can grow to the sky.
Rental parity becomes a baseline — a fundamental. Prices are loosely tethered and may depart for long periods, but prices always manage to return to rental parity in time because as a logical point of indifference; it is the natural resting point for a market purged of kool aid intoxication.
Rents Capture Premiums
Rental Parity provides a useful measure of desirability and premium. When people are deciding between renting and owning and comparing costs (you all do that now, right?), some will chose to rent and some will chose to buy. Both parties are going to take a portion of their income and go obtain housing in their own way. Neighborhoods with high rents will have high home prices, and neighborhoods with high home prices will have high rents. The intrinsic desirability will be mirrored in the rental and for sale markets.
Applying Rental Parity
Rental Parity is a guideline for value, but this number can be refined to adjust for some of the intangibles of ownership — good and bad.
Each property is evaluated to determine its
desirability as a long-term residence — this is an opinion; it is not a mathematically provable. If
the best properties in the entire market would rank a 1, and if the
very worst would rank as a 5.
The little green dot represents a subjective evaluation of a property.
The black dots represent different important price points every
buyer should be aware of. The first is the “value,” if you want to call
it that, of comparable sales in the market. This has nothing to do with
cashflow, and it is based totally on what people are currently paying
for similar properties in the market. The
Comparable Sales Value floats up and down this chart based on whatever
people are currently paying.
The next black dot on the list is the asking price. This can also be
just about anywhere. The frequent WTF listing prices I profile here
would be off the top of the chart. Some short sales are priced well below comps to attract attention.
The next black dot on the list is the Maximum Cashflow value of the property. Do you remember the post, Investment Value of Residential Real Estate?
As I described in that post, there is a legitimate
financial reason to pay more than rental parity for blue-chip
properties a buyer plans to own for 10 years or more. This is not a
large premium over rental parity. The calculations in that post
demonstrate you can pay up to 10% more than rental parity on a
long-term hold because you obtain the benefit of the inflation hedge.
This is not a price point for homes you know you will want to move up
and out of in a few years.
The next black dot on the list is Rental Parity.
The zone between rental parity and cashflow investor levels is the
gray area where all the less desirable properties fall. This would
include most condos, any two-bedroom properties and what are commonly
known as “starter homes.”
The final black dot is the cashflow investor level. This is the
price point where an investor can acquire a property, rent it out, and
turn a monthly profit from owning the property. This is the bottom of
the line for Irvine properties, and it is usually about 25% below
rental parity.
The final number on the chart would be those properties nobody wants
to live in. Does everyone remember Dr. Housing Bubble’s series Real Homes of Genius? Those are the properties I am talking about. What they really need is a bulldozer.
Moving Beyond Rental Parity
Are their influences on the prices of homes beyond income and rent? Are there properties, neighborhoods or communities where money is stored like a reservoir, and values are sustained at levels not justified by incomes?
I have been contemplating the disparity between home prices and incomes in areas like Malibu to see if there really is something that makes certain neighborhoods or certain properties conform to a different set of rules.
In areas like Malibu where there are many cash buyers, prices are determined more by the wealth of a few than the income of the many. Any times you get truly unique properties of very high quality, and the people competing to own them are not wage earners, they are people of great wealth who see something they want. They are bidding on percentages of their net worth rather than percentages of wage income.
When the disparity of wealth sees a shift toward wealth concentration (our recent governmental policies have favored wealth concentration), special properties in a place like Malibu get bid up to very high prices. The prices go so high because the people bidding have very large fortunes. For some of these people, a $20,000,000 house is a small fraction of their holdings.
The implication is that real estate in places like Malibu will be subject to fluctuations in the general pool of wealth in society. Since deflation has ravaged people’s investments, real estate will likely fall in equal measure.
That is all very interesting for Malibu, but Irvine is a working-class city where property values are largely determined by income. Is there any stored wealth in real estate here?
Uniqueness and Quality
There are only two things that creates the capacity to hold wealth beyond cashflow value in real estate; uniqueness and quality. To illustrate the value-adding feature of uniqueness, I thought I would share with you a great scene from an episode of Star Trek The Next Generation. Commander Data, a one-of-a-kind android, has been taken hostage by a wealthy collector who is obsessed with unique objects.
Clip is 5:00 in the video, or click the link below; it is at the right starting point.
The Most Toys — Star Trek The Next Generation
Uniqueness adds value. Wealthy people will compete with one another to obtain unique items, and they are not subject to pressures of financing. When you enter the realm of unique properties, you abandon ideas of Rental Parity.
If something is unique, substitutes are limited. An architect designed mansion on the beach is completely unique, and there is a limited number of comparable properties. When you see properties like the Hearst Castle, there simply are no comparables. In Irvine, there are few unique properties; most properties have many close comparables. Many floorplans are duplicated around town, and properties with comparable sizes and configurations are everywhere. Most of Irvine is an undifferentiated mass.
Quality adds value. Donald Trump, whatever you may think of the man, always strived to create the highest possible quality in his product, even if the pricetag was beyond ridiculous. Most people think pergraniteel is adding quality; it isn’t. Pergo wood flooring is imitation wood, and nothing of quality stands in imitation. Quality is not cheap. Most attempts at quality end up as over-improvements and return less value than cost. There are some very high quality, unique properties in Irvine, mostly in Shady Canyon because it is the only neighborhood where lots are big enough to create unique estates.
Reservoir of Value
Real estate can be a reservoir of value. When properties are unique and of very high quality, the wealthy become interested in possessing them, and prices become based on wealth rather than income. These properties are few and far between. Irvine is not a community where homes will be a tool of the wealthy. Our real estate is simply not that unique, and it is generally not at exceptional levels of quality. That doesn’t mean individuals in Irvine do not store wealth in real estate. Anyone who pays down their mortgage and enjoys appreciation from wage growth can accrue a substantial nestegg. The value of that nestegg in Irvine will always be determined by local wages not by the buying and selling of the very wealthy.
Asking Price: $1,425,000
Income Requirement: $356,250
Downpayment Needed: $285,000
Purchase Price: $875,000
Purchase Date: 7/14/2000
Address: 34 Coldbrook Irvine, CA 92604
| Beds: | 4 |
| Baths: | 3 |
| Sq. Ft.: | 3,400 |
| $/Sq. Ft.: | $419 |
| Lot Size: | 7,210
Sq. Ft. |
| Property Type: | Single Family Residence |
| Style: | Traditional |
| Stories: | 2 |
| View: | Hills, Lake, Mountain |
| Year Built: | 1979 |
| Community: | Woodbridge |
| County: | Orange |
| MLS#: | S581546 |
| Source: | SoCalMLS |
| Status: | Active |
| On Redfin: | 5 days |
Picture yourself hosting friends and family in this beautiful, largehome with views of the Woodbridge North Lake from almost every room.
Entertainer’s back yard with pool, spa and expansive wood and concrete
decks. Roomy master suite with vaulted ceilings, sitting area and
balcony overlooking the pool. Beautifully appointed formal living and
dining rooms with hardwood floors and fireplace with custom mantle.
Expanded kitchen with breakfast nook and counter. Huge upstairs bonus
room with brick fireplace. Downstairs bedroom/office with adjacent 3/4
bathroom. Large laundry room with sink. Crown molding, updated doors,
windows and baseboards. Intercoms in most rooms. Many parts of home are
wired for audio from the entertainment center. Inside the loop location
just steps from lake, tennis club and swimming lagoon. Walking distance
to elementary, middle and high schools. *** No Mello Roos / Low HOA
dues ***
This must be the most entertaining property in Irvine.
Today’s featured property is very desirable. Finishes have been upgraded to the pergraniteel level, it has a private pool, and there is a view of the lake — albeit sideways. There are fewer substitutes for this property because of some unique features, but there are also some substitute houses that are superior (how about the homes right on the water?) It’s cashflow value is probably around $1,000,000. Is there $425,000 in uniqueness and quality here? Is the $1,425,000 price justified?
Excellent analysis and breakdown of the housing/investing market. Put slightly differently, an investor should normally begin by computing the Rental Parity value of the property. When one compares that to the perceived market value of the home, there is a delta that should reprsent the perceived value of having a put option on the housing market/RE inflation hedge (i.e., owner has some control over future housing payments, at least if they get a fixed rate loan, that a renter doesn’t have). It being understood that pure cash flow investments are junk (with maybe even a negative delta to ownership, until about two years ago it was becoming accepted in California that the Delta on a decent home in Irvine should be anything from 30% to 80% of the cash flow value; i.e., houses were selling for 180% of the cashflow value. Technically, one could argue that the free market sets the delta and that accordingly, the likelihood of continued RE inflation was high, and that accordingly the large delta was rational (just like one could have ARGUED that it made sense for banks to make no-money-down RE loans, provided their risk of default was properly priced — it was the risk of default that turned out to not be properly valued, of course).
In reality, that delta between market price and appears to have had a lot of irrational exuberance/ Tulip mania in it. We all agree on that now, and that it supply driven — the oversupply of money. So, to repeat your question back to you, what amount of ‘Delta’ is appropriate for a home in Irvine? 10%? 20%? Like all mathematical models, the answer will depend on your assumptions regarding inputs and future staes. Still, assuming property prices bottom out at near Rental Parity levels, that delta should be the real expected (as contrasted with the timing, or speculative) profit involved in making a real estate investment. A market price above the Maximum Cashflow value (a number that presumably will differ from investor to investor) gives a negative IRR and should be a clear “don’t buy” or “sell” signal. Likewise, like a positive IRR, a price under the Maximum Cashflow value is a signal to buy; the trouble is, the actual Maximum Cashflow value is damn hard to pin down.
Which brings us to the final point: because investing in real estate in inherently risky, a long term homeowner might conceivably be willing to pay more than the Maximum Cashflow value because of the psychology involved in being a homeowner. This “willingness to pay more” is at once irrational (doesn’t make financial sense) and rational (a home is a home, not an investment — you pay for what you can afford). If that is the case, the long term homeowner should be willing to pay more than a rational speculator most of the time. Perhaps this is one reason housing bubbles are so common.
.
http://www.crackthecode.us/images/just_picture_yourself.jpg
The phrase “Picture yourself” auto-completes to “in a boat on a river.” I spent the rest of the time reading that listing humming to myself about the girl with kaleidoscope eyes.
The premium over rental parity is based on the property rights that an owner retains when renting. The most common property right that an owner maintains is the right to sell the structure. As a renter, if you do a remodel, you don’t own that remodel, the home owner does.
In an older neighborhood, you will typically find lots with less house than is typical now. That is, they don’t already have a McMansion on them. IF, and that can sometimes be a very big IF, you can remodel or tear down and replace the existing home with a McMansion, then there is significant value in the property rights that the owner retains. In those neighborhoods, there could be a very large ownership premium.
In the 50’s, areas like Balboa and Malibu were seen as places for the Hollywood crowd to have weekend houses. So they tended to be very small. There are still a lot around. In these areas you do see quite a difference between the cost of renting (a shack) vs. owning (a mansion). But you have to be very careful. Ownership of the land doesn’t give you complete freedom to remodel as you see fit. Some areas of Turtle rock have more restrictive height limits than others. If you are looking at a townhome, you may not be able to change the exterior of the home at all. Smaller the difference between the property rights of an owner vs. a renter, the smaller the premium should be.
Dallas has a McMansion infestation in many of the older neighborhoods with 1/4 acre lots. There will be a 6000 sf atrocity right next to a 1960s ranch home on the same-sized lot.
In 2005-2007, builders were snapping up smaller and/or older homes on the big lots. They put up much bigger homes. By 2008, many of them has stopped building on spec and tried to sell vacant lots, build to suit.
Now, the high end new construction is just sitting. Lots of foreclosures in progress on the high end, especially where they were never sold or occupied.
The older smaller houses are doing OK. They are selling fairly well, at discounts of 10-20% from peak. The bigger homes, despite being one of a kind and in established neighborhoods, are seeing 30%+ price cuts and not selling.
The price compression is partly due to there being no conforming jumbo loans here ($417k-730k isn’t a separate loan type in Dallas). It’s also due to many people who had large investment portfolios experiencing large losses.
I suspect that one of the reasons people bought big homes was the expectation of appreciation. With that gone, only the people who really wanted to live in big houses consider buying them.
“The premium over rental parity is based on the property rights that an owner retains when renting.”
Market psychology and the access to credit has more to do pricing than anything else. Real estate (especially in Orange County), is valued more on the availability to leverage, than anything else. Meaning … your home is only worth what a bank is willing to loan a third party to buy it for. If the banks are loaning lots of (free) money like they were after Sept 11, prices will go up, and suckers will keep the rally going, despite the lack of fundamentals.
I guess what I’m saying is I don’t believe your theory can hold, and prices in The OC will undoubtedly drop below rental parity, just like they did in the late nineties.
Property rights can impact the premium over rental parity in both directions. For example, the owner may give the renter both the right to live in the house and not have to do any maintenance. The inflation hedge is the result of property rights associated with not having to renegotiate the selling price in the future. Note, that when the Irvine company “sells” land to a developer, they don’t transfer this property right to the developer.
However, my point was with respect to the fundamental value, and not the irrational value due to bubbles and crashes. That in valuing the fundamentals, sometimes you need to go beyond just looking at rental parity. I’m not saying that you want to throw rental parity out the door, but that you might want to consider what the rental would be for a new house at that location vs. the old run down shack that happens to be there now. But, don’t forget to subtract out the cost of building that new house 😮
Hey … I agree with you about rental parity.
JMO ~ Rental parity, though important, is less relevant in a time of crisis like the one we’re dealing with now. Besides, if you’re like me (I think the economy is presently circling the drain), then rental parity is just a snap shot. As the economy continues to struggle, and economic fatigue beats away at anticipated recovery, price/rent expectations will continue to drop.
I remember seeing homebuilding advertisements in the late nineties for projects in communities like Aliso Viejo and Rancho Santa Margarita ($190,000-$220,000), that I know could have cash flowed a very positive gain right out of the box. Yet because people had been so fatigued by years of a crappy real estate market, they had reconditioned themselves to believe real estate was a losing proposition. The same thing is starting to happen right now.
Article on the problems of the Las Vegas market and how homebuilders are reacting to it:
REAL ESTATE: Outlook for LV housing grim
what better way to start my morning than Star Trek AND IHB! 🙂
I couldn’t help myself when I started writing about uniqueness as that episode kept popping into my mind. It is a great story of a man of great wealth (and no morals) who lost everything on a quest to collect one-of-a-kind items. Covetousness and jealousy on naked display — the essence of the value of uniqueness….
In using Malibu you are using the premise of a very limited number of people with a large amount of wealth, but that is not all different than having a large number of people with lesser, or “limited” amount of wealth. No?
“but that is not all different than having a large number of people with lesser, or “limited” amount of wealth. No?”
It may be.
Malibu may be a different case because there are so many cash buyers. When you get into communities like Newport Beach, there is much more of a blend between cash buyers and wage financing buyers. Cash buyers are competing with high wage earners, so if they really want the property, they will have to bid higher than a wage earner. This puts the property value above an income-dependent value like rental parity.
The difficultly with blended neighborhoods is that prices are impacted by either declines in wealth or declines in income. If all the wealthy people in Newport Beach do nothing, all the selling from the wage earners who cannot afford their properties will hurt prices. Certain streets or special properties may retain a significant portion of their value (if wealthy people buy them), but the aggregate will be dragged down to levels supportable by income.
The degree property values are dominated by wage earners is the degree property values will correlate to rental parity over the long term.
The degree property values are dominated by wealthy cash buyers is the degree property values will correlate with changes in wealth accumulation among the top few percent of buyers.
Both of these forces are at work, and both impact property values to some degree. The point of this post is to get people to realize that the impact of wealth is much more limited than most think. Market prices are set on the fringes, and when most sales are financed — as they are in Irvine — then prices are set by wage earners and financing terms. When financing is involved, Rental Parity rules.
“The degree property values are dominated by wage earners is the degree property values will correlate to rental parity over the long term.”
That’s a reasonable statement, but it ignores the in-between scenario that sits between a cash purchase and “standard” financing. If enough people put a mil, half mil, etc. down, then the amount over rental parity would then be that same amount (or at least the amount that is over a “normal” down. Susequently, if the average length of ownership is long enough to produce a similar equity postion, the end result is the same as putting a lot down. The second argument can be thought of as “The Nancy Phenomenon”.
It will be interesting to see how this plays out. Much will depend on what people with cash do.
Imagine a neighborhood where 1/2 the owners paid cash, and 1/2 are overleveraged wage earners who have to sell. If there are enough new cash buyers to take out all the overleveraged earners, then prices will not fall. If no new cash buyers step up, then prices in the whole neighborhood will drop to the new level of income and financing. This is one of the reasons The Irvine Company has tried to attract cash buyers from Asia to sustain prices that wage earners cannot.
Cash buyers are typically attracted to unique properties of high quality. Neighborhoods where those properties predominate should fair the best; although, even in these neighborhoods, prices may fall significantly because of the The Immunity Syndrome.
I always thought “Picture Yourself” referred to realtors photographing bathroom mirrors.
IR or anyone:
If a house is listed as short sale, does the owner still have to pay the full mortgage while the property is listed or there is some sort of deal with the bank to forgive the mortgage or reduced mortgage?
If the first case is right, then I see why the bank has no incentive whatsoever the speed up the short sale process.
I suspect that a homeowner has no incentive to renegotiate the terms of a loan to allow the owner to continue making payments while simultaneously putting the house on the market with the expectation that the bank, having just renegotiated the loan to preserve its principal investment, would now approve a short sale price for less than that principal. Assuming that scenario, the answer to your question is yes – the owner is still obligated to pay the full mortgage.
IrvineRenter: Does your above statement that cash flow investor level, “…is the bottom of the line for Irvine properties, and it is usually about 25% below rental parity” mean that, if rental parity is $2000/mo, then investor cost to own the property should be $1500/mo? Thereby allowing a profit after all expenses of $500/mo?
These numbers are based on your “Calculator” using 20% down, etc.
The actual calculations are more complicated that I represent, but 25% below rental parity is a good estimate. That is where the stuff in “The Lakes” and Orangetree will find significant support from investors. At those price levels, cap rates are in double digits, and an investor is making a much better return than competing risk-adjusted alternative investments.
“If we had … people who always acted rationally … any price above rental parity would be perceived as too high, and there would be no bid interest.”
Why?
30 years renting – you have nothing to show for it.
30 year mortgage – you own a house.
Wouldn’t a rational person -always- pay above parity to own? Since at the end of the 30 years you own a house versus owning nothing (in the rental situation).
That’s the fatal flaw in the argument, isn’t it? It dismisses the #1 reason people buy homes.
The only fair comparison is if you –sell– the home after the 30 year mortgage is paid off.
That way at the end of 30 years of renting or paying mortgage you end up in an equivalent situation (where in both cases you don’t own a home).
Rental Parity should be redefined.
Rental Cost could be calculated as:
Rent payment over 30 years
Home Ownership Cost could be calculated as:
(Total Mortgage Paid over 30 years – Sale Price of the House.)
This way you don’t own a home after 30 years; which is more comparable to the rental situation.
The calculation of Costs could be more sophisticated by factoring all the other costs of rent and ownership like IrvineRenter has done in his calculator.
You gave one of the main reasons (other than pure economics, if buying was above rental parity) for buying over renting. The others are a sense of permanence, and the ability to modify the property to your individual tastes.
On the other hand, there are two main reasons why somebody would rent as opposed to owning:
1. They plan on being at the home for a short period of time.
2. They have poor credit and/or no down payment. Less of an issue during the bubble than now or historically.
In areas with lots of either (or both) of these, rents should probably be above rental parity.
I’m in Riverside, which qualifies for both. Lots of short term renters (due to UCR, La Sierra University, and Cal Baptist University all being in the city-college students are frequently in an area temporarily), and a fair number of poorer people with poor credit and/or no down payment. Rents are therefore way above rental parity now-not so during the bubble, due to reason #2 not being a factor, because anybody could get a loan with no money down.
I should have said “purchase price should be below rental parity”, to be clearer.
So to buy now (intending to rent) using a cash flow analysis exposes the investor to the possibility of continually falling rents to the point where – poof, no more cash flow for who knows how long?
Depends on the location. I doubt rents in Riverside (to continue my example) will drop by much, if at all. But I also think sale prices have bottomed. Plus, rents will certainly be higher in ten years, in twenty-but your house payment will be the same. And in thirty years your house payment will be zero.
Now, I’m mainly talking about an owner/occupier. Buying a rental property for a cash flow investment is much riskier. But the same general logic does apply-rents in the long term will increase, and your payment will be stable for thirty years (minus taxes and insurance, of course) and then drop to zero (again, minus taxes and insurance).
“Plus, rents will certainly be higher in ten years, in twenty-but your house payment will be the same. And in thirty years your house payment will be zero.”
I’m not certain where we’re headed, and I apologize for mentioning Japan yet again, but deflation has been known to occur.
In such a case, rents drop while owners can either suck on their stable, but less affordable payment, or quit. Renters, by virtue of not being locked into a long-term contract, would win in that situation.
I would bet that you’re correct, but it’s not a dead-cert thing.
Deflation is extremely unlikely over the long term (five or ten years or more). In the short term, it happens to be fairly likely, but only until the economy recovers.
30 years renting – you have nothing to show for it.
What about a substantially larger bank account? Do you know how much money you spend in interest over those 30 years? Your interest money can be almost equal to the original purchase price of the house if you put down very little.
30 years is a very long time. What are the odds that you are really going to hold it for that long? For most people, the odds are roughly equivalent to a snowball’s chance in hell.
What do you do when you are into year 5 of your mortgage and you decide that your boss is a jerk and your coworkers are morons and you are ready to move on to that next big opportunity that requires you to leave town. You will have to sell your house and pay lots of money to fix it up, install pergraniteel, commissions to realtors, and title companies who will all have their hands out along the way. The money you spend in fees and fixups will undo all of the equity you built over the previous 5 years and bring you back to square one.
The renter just pays the fair market rent from year to year which can be to the chagrin of the landlord if fair market rent is below his carrying costs.
Rent cheap for 10 years, save up a large down payment and buy using a 15 year loan and you come out way ahead of the 30 year debtors. The 30 year loan is total charade. It worked fine back when people bought land that they would settle on and farm for the rest of their lives, but today it is an outdated dinosaur that needs to be thrown out. It does nothing but enslave people to lives as endentured servants to banks.
The situation I was referring to was only at rental parity.
Meaning one person is rental for 30 years.
Another is paying mortgage for 30 years.
They are paying the same. Rental costs and Home Ownership Costs (mortgage + maintenance + taxes, etc) are equivalent.
At rental parity you save no money by renting compared to owning.
I would agree with you if you rent for the exact same price as a mortgage payment then it would equal out over the 30 years, but I don’t see this happening realistically as life circumstances change and mobilty commands a premium.
There are a lot of people who live in one house for the entirety of a thirty year loan (and beyond). It’s not nearly as rare as you would think. If somebody is well established in a community and has an extremely stable job, buying a house at 35 so one can have no house payment at 65 makes a lot of sense, IMHO.
There are a lot of people who live in one house for the entirety of a thirty year loan (and beyond). It’s not nearly as rare as you would think.
What percentage are first time buyers? Therein lies the rub.
Please enlighten me:
1. How am I wrong that monthly cost of ownership is ~ twice cost to rent?
2. How am I wrong that your example is not at rental parity?
I’d happily look at whatever problems you see with my methodology, but my conclusions seem pretty correct. Looks like if you’re only going to stay 7 years in the fictional property you described, you’d be better off renting than owning.
This should be lower down.
“Wouldn’t a rational person -always- pay above parity to own? Since at the end of the 30 years you own a house versus owning nothing (in the rental situation).”
Go take a look at The Investment Value of Residential Real Estate. The inflation hedge has significant value, particularly for very long ownership periods. In fact, it is the best reason to own real estate. However, people do not generally own homes for 30 years. The national average is about 7.
Ownership is a burden, and in a normal market, it takes 3 years of appreciation just to get back your transaction costs. If you also overpay and have excessive monthly payments, you dig an even deeper hole that appreciation must fill. The additional costs of ownership for those that overpay eat up the advantages of appreciation rather quickly.
So the answer to your question is “no.” It is rarely wise to pay above rental parity, and the only reason that can make it right is if you own for a very long time.
“Wouldn’t a rational person -always- pay above parity to own?”
The 30 year commitment to a piece of property should be payment enough. You don’t pay up for an inflation hedge…that’s counterproductive. Your already making the long term commitment to spending capital on the property every month. Paying up for the right to do that, especially in THIS market, doesn’t seem very smart.
I think I misunderstood your definition of Rental Parity.
I’m going to have to go over this post more carefully:
https://www.irvinehousingblog.com/blog/comments/rent-versus-own
Anyway I’m here to learn and you’ve certainly given us more than a few good lessons.
Thanks IR.
The inflation hedge can move against you. Either there can be outright deflation in most things (wages, houses, beef, gas, cars, etc.), long term deflation in home prices alone (e.g., Detroit), or just lower inflation than was embedded in market prices (e.g., average of 1% over a long time period, instead of 3-4%).
Deflation means debtors have to pay mortgages with more hours of work, years of salary, or control of other expenditures. Very low inflation means pretty much the same thing, just to a lesser extent. The primary difference comes when selling your home. Unanticipated deflation makes it harder to pay off your loan when you move. Lower than expected inflation means you probably don’t get a big chunk of cash when selling.
No, the rental parity computation treats the principal portion of a mortgage payment as an investment rather than as a cost equivalent to rent; accordingly, that consideration is already embedded in the analysis.
^^ I realized this after posting.
This property featured today was on the market for basically all of 2008 at a lower price and it didn’t sell. Even though the view/pool/location is nice the layout is actually a bit strange inside with a small sunken living room and kind of an awkwardly shaped kitchen. It’s interesting that the seller priced it higher now – they must think there is a rally going on since there have been a few higher end sales in Woodbridge lately.
There is another property for sale in Woodbridge for over $1.2 million, and the agent told me that it is also available for rent for $4,400 per month. The current owners bought the house for almost $1.4 million so unless they paid all cash the rental parity math doesn’t work out too well for them….
This example is closer to what IR is getting at. TCO ~ $7k/mo, or $2600/mo mothan renting. If in 1yr it falls to $1M it’ll be $5800/mo tco, but what will rent be? Another 1yr, maybe down to $800k? $4.6k/mo tco, while rent may be $4k. Think about the relative deals
Price Rent App. prem/mo
$1.2M – $4400 – $2600
$1M – $4200 – $1600
$800k – $4000 – $600
If one of the true values of buying vs. renting is as an inflation hedge, and we are in a deflationary environment, what value is the inflation hedge? Holding money in cash and saving more is a deflation hedge. For at least the next year or two, which will be the bigger problem – inflation or deflation?
The math is really, do you rent & save the extra $2600/mo, or buy and lock in today’s price? The additional hedge in renting, mentioned above is the move/lose/need-to-change your job hedge.
Chuck makes good points. Also regarding this tiny slice of Woodbridge– the house across the street was on the market and “sold” almost as soon as it was listed at $899K only to fall out of escrow 2 weeks later. They relisted at $929K (??? Guess there were so many buyers pounding the door down to buy it) but alas, it is now been reduced back to $899K and still showing active.
Also – there is another home for sale on Live Oak (around the corner)for $1.4M that had sold approx. 1 year ago for $1.2M (I know there has to be a good story about that one!).
But it is curious– because this subset neighborhood in Woodbridge generally has very little turnover and now we are starting to see more movement.
Is anyone else noticing that the seems to be more price increases on existing listings in the last two weeks?
I am seeing the increased asking prices in the charts on Redfin as well. I have mentioned before that any spring rally would bring out the discretionary seller and their WTF asking prices. Now we are seeing them.
My neighbor had his house on the market for a few months and went into escrow which then fell out after two weeks. They decided to raise the price by around $20K and then received a few offers within the same week which they accepted one. The second accepted offer was much higher than the one that fell out. It is funny how the house did not change at all. The only thing is a few weeks went by and they raised their price and had MORE interest.
Why are buyers doing this? It makes no sense to me and I am a seller!
If the initial asking price was way too low, people might automatically assume there’s something massively wrong with the house.
Well, if the price was $50-80K difference maybe I would agree, but a $20K spread seems too small to give the ‘something wrong’ impression? Maybe I am off base?
“Why are buyers doing this? It makes no sense to me and I am a seller!”
Some of this is people acting like it is 2004 again. The kool aid still flows with some buyers.
Being a seller right now is like playing a lottery. If your property generates buyer interest, you get to cash in your ticket; if it doesn’t, you don’t.
Email me, and I will do a report for you like the one in this post: 14802_Devonshire_Ave_Tustin,_CA_92780
IR, do you think that the first time home buyers credit is affecting the Irvine home pricing (or rental parity)?
I feel that rational markets would price in the tax credit and home prices would reflect the same. if that is the case then would the housing market tank some more when the tax credits expire next year?
On the other hand the emails that i get imply that this is the best time for renters like me and i would be a fool to miss out on that tax break (i agree that it is substantial), appreciate view point.
Irvine houses are (for the most part) way too expensive to be affected by the eight grand tax credit-there are income limits ($75k single, $150k couple).
Lower priced areas are affected by that credit-it’s one of the reasons the low end is booming right now.
Exactly, the impact has been much greater in Riverside County than in Orange County for the reasons you describe.
Thanks Geotpf & IR… i wasnt aware of the income limit.
Great NYT article:
Subprime brokers mutate into loan fixers
“We just changed the script and changed the product we were selling,” said Mr. Soussana, who ran the Los Angeles sales office of Federal Loan Modification Law Center. The new script: You got a raw deal, and “Now, we’re able to help you out because we understand your lender.”
I like how these guys call it a “product” as though something of value is actually being made rather than just call it what it is: a bunch of unscrupulous hustlers acting as agents on behalf of FB’s. In other words, white collar prostitution.
Most of these are scams, and even the ones that aren’t scams give you no value added. There’s nothing these guys can do to modify a loan that a homeowner can’t do themselves.
I’m pretty sure modguy said the same thing a few weeks back.
Sorry for a comment on what is probably covered in another one of IR’s most excellent posts, but I didn’t see any category in the calculator you linked to above to inflation? Over time owning a house in an inflationary environment will hedge your risk vs renting and the value as an inflation hedge would seem to be worth something mroe than zero.
Here’s how I think about it with my situation. When I bought my house in 1992 my cost to own was very close to renting (which is why we bought then it was a weak market at that time). Had I rented my house, I’d now be paying say $2600/rent vs about $1600 market rent in 1992 due to inflation. My salary has risen roughly in line with inflation so if had been renting this whole time, I’d still be paying about the same % of my monthly income so I’d be no better or worse off.
However my P&I component of my mortgage has been flat since 1992 (lower, actually, as I refi’d to lower rate and prepaid some debt with a small inheritance, but lets’ ignore that for this analysis). Even ignoring the refi, my P&I as a % of my monthly income is lower today than it was in 1992. To put another way in 1992 in 2002 the P&I part alone was about $300 less than rent and today it is about $1300 cheaper than the rent. Now the other expenses like prop tax are higher, but not $1000/month higher.
If you assume a house appreciates only at CPI (which assumes that wages, which support rent, only grow at CPI) inflation is devaluing your your mortgage. You are building equity only due to the inflation hedge, but you are essentially using that equity to lower your real cost of ownership, as your housing cost is falling as a % of your income.
To put it another way if I had been renting all these years and I could now buy my home at rental parity, I’d be spending alot more of my income to buy my house today than I am actually doing because I bought at rental parity in 1992.
So it seems that if you factor in inflation (and, of course, there is a risk that inflation could be zero for a long time), and you are at rental parity you may be better off owning?
‘Inflation’ can be negative too, and if you have home prices and rents falling than the hedge has a negative value.
In most markets, during most times, the inflation hedge you mention does have value.
While I agree with you, until very recently most people thought that the hedge they were entering would protect them from high inflation times like the early 1980s. They weren’t really expecting deflation. Unless they were quite astute, they probably didn’t realize that the hedge could move against them even with prolonged low inflation rates like 1-2%.
Again, why pay UP for an inflation hedge? You’re betting on the come, hoping for inflation to hit so that you’re in a better position. Ask a 2004 vintage homebuyer how they feel about their inflation hedge?
Buying is the inflation hedge. Paying up for it in the hope inflation hits is a bad idea.
Scott,
I talk about the inflation hedge in great detail in Investment Value of Residential Real Estate.
You are correct that it does have significant value over the long term, but it isn’t a premium you want to pay for up front. I have a chart in the investment post showing the value of the inflation hedge based on ownership period. As Dan pointed out, “Buying is the inflation hedge.”
Thanks for the replies all – still getting up to speed…if only someone had written a book (which I’ve been intending to but and will shortly).
Thanks for sharing your real-world experience!
I think we all look forward to buying once prices bottom and enjoying this extra long-term benefit of home ownership.
Here’s my generic questions/comments for the week after looking at open houses over the weekend.
1. Does the owner or the agent typically decide to have an open house? Does a realtor typically charge extra for hosting an open house?
2. Yesterday 3 of the open houses I saw in Ventura County I had been through previously. One was open the week before, and two of them were open about 2 months ago. I assume this is a good sign for buyers if a house has to be open for multiple weeks (especially months apart)?
Open houses are held at the discretion of the homeowner. Real Estate agents typically hold open houses to meet prospective home buyers, not to sell the house. There is considerable pressure put on new agents to hold open houses so that they can get the names and addresses of home buyers, this is not necessarily a bad thing for a home buyer. In some cases the real estate agent promises the home seller to hold open houses with the idea that this is likely to sell their home. It is very rare to sell a home to a buyer who first viewed the home at an open house, but it does happen (I bought my home that way).Homes that hold open houses several months after being put on the market are usually held open to demonstrate to the home owner that the real estate office/agent is actively trying to sell the house, though the real motivation is that the real estate agent is trying to meet new buyers.
That is interesting.
I guess that helps explain a lot of the bullshit I listen to when I go to the open houses. I guess I need to (incorrectly) tell them that I already have an agent.
It didn’t quite make sense to me why the listing agent would try and get a lot of information about what I’m looking for, how much I’m looking to pay, am I financed, and “you should just make an offer of what you think the house is worth”.
Irvine Renter, I have to take exception with your math again. You say a seven year holding period favors renting, but not according to my calculations.
To keep it simple, set aside tax benefits, lost interest income on down and principal hidden in payment.
$300,000 start home price
$408,258 end home price
$1,500 start rent
$1,953 end rent
4.5% appreciation on both home and rents
7% selling costs
5.5% interest rate
$240,000 mortgage
$60,000 down
No HOA
1% property tax
PI payment per year = $16,352.28
Taxes per year = $3,000
Insurance per year = $1,500
Owning:
Outlay = $60,000 + (($16,352 + $3,000 + $1,500) x 7) = $205,965
Recoup = ($408,258 – 7%) = $379,679
Profit = $79,679 (after paying back your $60,000 down and $240,000 mortgage)
Renting:
Outlay = $144,344
Recoup = $0
Loss = ($144,344)
I made an error. The owing option also produced a loss, but of $66,286 ($379,679 – ($205,965 + $240,000)). Still better than a loss of $144,344.
Your math is incorrect, and its quite confusing trying to figure out what you’re looking at.
I’ll use your figures, cause I don’t feel like doing the inflation calculations.
The renter pays $1,500 a month the first year, up to $1,950 a month for the last year.
The homeowner is paying $1,363 in p&i every month at their 5.5% rate. However, to get that, they need a $60k dp. Also, they are paying $31k in tax & insurance over 7 years. Plus $28,578 in closing costs. Those three costs, averaged over 7 years, are an additional $1,423 a month.
Which means it costs $2,786 a month to own this home. That is NOT RENTAL PARITY.
Let’s take this a step further. The renter paid out $144k over 7 years per your calculations. The homeowner, in addition to the out of pocket expenses listed above, paid $76,756 over 7 years in interest payments. Total out of pocket expense over 7 years for your homeowner = $60k dp + $76k interest + $31k (tax+insurance) + $28.5k closing costs = ~$196.3k. So the homeowner paid out of pocket more than the renter. Of course, after sale of the property, the homeowner will get a check for $195k ($408k sale price – $212,775 still owed on loan). So the homeowner is out of an asset, and their net gain/loss is -$1,000 versus the net loss to rent of $144k.
But let me again point out that the owner had to pay twice as much every month to own that same property, so the renter could have saved another $144k to come out even.
And that’s assuming 4.5% inflation every year, and that rental prices move up to match. Since we’re in a deflationary period, the numbers are even more skewed to renting vs. owning.
tldr version: If you ignore the meaning of rental parity, you can make numbers do whatever you want.
You are 100% wrong. Everything you mentioned was addressed.
Please enlighten me:
1. How am I wrong that monthly cost of ownership is ~ twice cost to rent?
2. How am I wrong that your example is not at rental parity?
I’d happily look at whatever problems you see with my methodology, but my conclusions seem pretty correct. Looks like if you’re only going to stay 7 years in the fictional property you described, you’d be better off renting than owning.
For starters: you double-counted taxes and insurance and you are adding in closing costs that I already took out of the profit. The costs to own is extremely close in this example. It is nowhere near what you are saying.
PI = $1,362
Tax = $250
Ins = $125
Total = $1,737
Yeah, there is maintenance and interest lost on the $60k, but there is also tax savings and principal hidden in payment. How the heck you get double is beyond me. By the way, this theorhetical home could be anywhere is the US. Theory is theory.
I get double cause you are conveniently leaving out two considerations:
1. The $60k dp is being paid. Gone. That’s a cost of ownership…that’s money out of pocket.
2. Closing costs are a payment. Out of pocket. Gone. Average that out over the same time period.
I don’t see that I’ve counted tax&insurance; twice. Where’s that one at? Instead of covering this thing twice, I’ll explain further below.
Dan in Fl, the closing costs were taken out when the 93% against the sale price was applied and the $60,000 was returned at the same time. Both of these things are already counted. If you want to apply them on a monthly basis, then you need to add in appreciation on a monthly basis too, not just at the end. You see how that works?
And I am correcting your math on that point because it is just wrong.
Look at the closing example below. The only thing that matters at closing is who writes a check for what. The buyer writes a check for $400k for the purchase price. The escrow agent writes 3 checks, one for closing costs, one for repayment of the loan, one for gross profit.
Check the calculations below. Gross profit and net profit are explained.
Dan, I can’t teach you anything more. Your mind is made up and you are impenetrable.
Quite the opposite, actually, if you give it a try. I’m open to hearing you out.
“But let me again point out that the owner had to pay twice as much every month to own that same property, so the renter could have saved another $144k to come out even.”
Your math skills leave much to be desired. You made about 6-8 mistakes. Also, please explain how the renter will close a $144k gap (in your own example)?
So, if I understand your above example, we’re dealing with an individual with the choice to buy or rent the same exact house. Lets call him Ben. Ben has $60k in cash that he can put towards a downpayment. If he buys the home, his initial payment is $1,500 a month, and his landlord will adjust the payment 4.5% per year. If he buys, he puts all his $60k down on a $300k purchase price, and will get a loan for $240k at 5.5%. Sam will get 4.5% annual appreciation on his home. Sam knows he will stay in this property for 7 years only.
Here’s where my figures come out:
If Ben buys, he gives his $60k to the seller, and takes out a loan for the rest. This is a real cost…his money is gone. I simply add that to the cost of staying in the house for 7 years because I consider that an expense of ownership. That’s $714 dollars a month, he just paid it all up front.
Ben pays $1,362 a month on principal and interest. On top of that, he pays $4,500 a year in taxes and insurance (somehow not adjusted for inflation, but it’s your example). That’s $375 a month. Before it’s time for Ben to sell, he’s spent $1,737 a month (mortgage payment + taxes/insurance). For this calculation I kept the 7% sales price out of the equation, even though it’s a cost of ownership (cost of sellership?).
But it’s 7 years later…time for Ben to sell. His sales price, exactly adjusted for 4.5% inflation in your example, is $408,258. After 7 years, Ben’s mortgage is at $212,775. His closing costs at 7% of $408,258 are ~$28,500. So, his gross profit on the sale is ~$166,983. But that’s gross profit…what did it cost him to get that check for $166.9 k. Well, he had to pay $60k as a dp. He had to pay $76.7k in interest payments to the bank. He had to pay $31.5k in taxes and insurance. All told, over those 7 years Ben paid sunk $168k into ownership costs, and got a check back at closing for $166.9.
Ben is just below break even if he buys.
Now what if Ben rents. Since Ben planned on using the $60k for housing, lets say Ben uses the $60k to help pay off his rent. Ben uses $714 a month from the $60k in his mattress to pay the rent, then makes up the difference from his salary. Over the life of the lease, Ben’s average monthly rent is ~$1,725 a month. Ben’s monthly out of pocket rent is $1,011 a month to rent, compared to $1,737 a month to own. Ben has an extra $726 a month that he doesn’t have to spend on housing.
If Ben uses the $60k for housing, at the end of 7 years he’s spent ~$85k in rent out of pocket ($144k – $60k) but he’s also been able to save back $60.9k. So if Ben rents, he’s $20k poorer than he was before.
So the difference to Ben in owning for 7 years in your example vs. renting for 7 years is that Ben lost $1k over 7 years by owning. Ben lost $20k over 7 years by renting.
To add, these assumptions are also quite skewed in favor of the owner. You’re assuming no increase in tax/insurance, assuming appreciation at that rate, and assuming a landlord will have the ability to raise rates at that rate. Assuming no other costs of ownership.
I have an appointment, but I will go over your scenario later. In broad strokes: each person paid approximately $1,700 per month (early on) and each got a roof over their head in return. However, the owner saw gross appreciation of roughly $80,000 (on his $60,000 investment) while the renter is out roughly $145,000 (less the return he could have gotten on his $60,000).
If we’re going to compare the scenario in that way, then the renter isn’t out any money, neither is the owner. They both pay ~ the same per month to rent, assuming that is rental parity.
The owner starts with $60k, leverages up, and ends up with ~$140k. That sounds right…that’s what happens when you leverage.
If the renter takes his $60k and invests it at 6.5%, he’ll end up with ~$80k.
Maybe I really am doublecounting in there. I think you are too, if you are counting the rent as a loss, without counting all of the owners expenses as also a loss.
The property tax payments are usually a wash due to the tax deduction Ben can claim. That adds to his profit in your calculation.
I’ll use South Florida as my basis point and say that neither rents nor prices will appreciate at 4.5%/year. If general inflation gets that high, you will have mortgage interest rates much higher than 5.5%. The example you show above is highly dependent on
1. inflation/appreciation rates
2. current home sale price/rent
Lower #1 to possibly even negative, and increase #2 and the match swings to renting. As #1 levels and looks to be positive, and as prices and thus #2 comes down, buying is better.
Look to the example from Chuck above. Price is 4X but rent is less than 3X, and there is probably price depreciation to expect over the next 7 years, not appreciation.
The models & comparisons themselves do not favor renting or buying, it is only after you put in the conditions that any sort of meaningful information comes out. If the conditions you put in are skewed to favor one or the other, and end up not coming to fruition, then you will probably have made a bad decision using a good model.
My advice would be to not go increase your DTI thinking the ‘built-in’ appreciation justifies that increased value.
This argument starts with rental parity and your arguments don’t hold water versus history.
Huh? Obviously, if you’re at rental parity, then an owner will benefit from home appreciation and the inflation hedge, but they’ll also suffer any price depreciation or deflation.
Your theoretical example assumes rental parity and 4.5%/yr appreciation.
If your option is really buying @ 300k, or renting at $1500/mo, and you’re planning on long term > 5 yrs, and the payments are not a stretch, buying is probably not a terrible idea.
I’ll ask, what did that $300k home sell for 3 years ago? >600k? Probably rented for the same $1500/mo. At that point you would have been much better off renting.
Theory is theory. It is right or is is wrong. The home in question could be in Corona, or the numbers could be increased across the board and it could be in Aliso Viejo. The priciple remains the same.
Wow, a place in Irvine without HOA and no mello roos and under 300k and still appreciating at 4.5% per year for the next seven years!
Haven’t you noticed that there hasn’t been much appreciation last 4years – prices are now at 2004 levels again and likely to go down another 19% according to some studies. Try working that into your numbers and see how that looks… Yes, it may not happen, but even if it is a 5 or 10% drop, your numbers wont look so good. I am not willing to take the risk and I would not be so optimistic in my calculations. In fact, I would be a little pessimistic base on continuing ecomonic degradation (unemployment, people moving out of Irvine after layoffs).
Also, keep in mind that rent dropped about 15% last year or so, just check all the incentives on leases they have from Irvine company and other rental properties…
I’m talking theory, same as Irvine Renter.
I think I will stay out of a debate on math. I am quite comfortable with the math presented in the posts and on the calculator. People can debate assumptions, but math is what it is.
I prefer to examine properties based on a stabilized first-year cashflow basis. Once you introduce projections for appreciation and inflation and stuff like that, it becomes far too easy to manipulate the numbers to make it say whatever you want. Discounted cashflow analysis helps but it does not answer all the questions. BTW, the problem with your analysis is that you are failing to take notice of the time value of money. The large upfront downpayment is a big cost, and the appreciation boost at the end does not look so big when you discount it properly.
This is certainly a personal flaw of mine, but I can’t stand it when people make bad mathematical calculations, even when their using flawed assumptions. Even if people can use numbers to say anything, doesn’t mean they should be allowed to.
I deal with this with my clients all the time. I have to point out how they cannot afford to stay in the home, how the banks can’t afford to do a loan mod that low, how they are better off renting and saving money while they repair their credit, etc etc.
Irvine Renter, I let it go before, but not this time. Your math is wrong. Your premium for investment value placed at 10% is completely wrong and based upon math that is also wrong. In that article you used PV of numbers that were greater than the numbers themselves, which proves to me that you do not understand what you are doing. You need to prove yourself with numbers that you can both explain and defend. You speak with much authority, and that is enough for everyone else here, but with respect: it is not enough for me. it is critical to your loyal readership that they understand the true nature of real estate investing.
Dude, it is your math that is wrong. If you go back to the post that started all of this, you would see that someone even showed you why your math was wrong and mine was right, and you wouldn’t hear it. I can’t believe we are debating math; it is either right or it is wrong, and yours is just wrong. You have been calling me out and I have been trying to ignore you so not to embarrass you, but my math is not wrong, and I am getting weary of your challenges. It isn’t like I am doing this math manually; I use a spreadsheet — one which I gave you direct access. If there is a formula error, show me and I will fix it; otherwise, we are not debating math, we are debating assumptions. Please see the difference.
You didn’t prove how my math is wrong, but I did prove that yours is wrong (because you can’t have PV greater than a future amount). Show me exactly where I am wrong. I don’t know Excel well enough to decipher where your formula went wrong, but it did. Use the examples from today to show me how you arrive at a 10% premium. You are saying that a $300,000 home is worth only $330,000 to account for all future appreciation and to that I say: BUNK!
Here’s another way I can prove your 10% wrong:
If you bought an investment for $30,000 that compounds at 4.5%, after 30 years you would have $112,359. In my example, the home appreciated almost that much after seven years, but the value of the underlying home increased to $1,207,097. You are taking the position that the true value of being able to make $907,097 is $30,000.
You can’t stay out of a debate on math. That is unfair. Defend yours or admit you can’t. FYI, a gain of $100,000 discounted at 4.5% over seven years is still $73,482.
Perhaps you should try reading Timing Does Matter.
Dude, stop posting your own written theories in defense of your theories. You are trying to reinvent real estate as an investment class. Your “Rent versus Own” calculator says everything anyone needs to know about your school of thought: there is no investment value in real estate. Your calculator, which you call “Rent versus Own” is a “Rental Parity” calculator only. Google “rent versus own calculator” and check the top 100 sites and you’ll see that every last one is forward looking and includes appreciation rates. Only yours is different. Unfortunately, the rest of the world does not agree with your world view. Best of luck pushing that agenda.
Apparently you can stay out of a debate with me, but IR can’t stay out of a debate with you?
C’mon man, really, what’s the deal here?
I told you, I had to go out. It’s difficult trying to argue with you because you have some very novel ways of looking at the numbers. Somewhere in this thread you said you could use your $60,000 to earn your way up to the future value of the home in the example. That is wrong, unless you’re a superstar investor.
IR and Freetrade, Good analyses.
The inflation or sale apprecision factors are making best estimations. (Almost always positive from RE agent and the RE industral analysts.) What the likely hood that houses will appreciate at 4% per year for the next 10 years? Factor in that interest rates are very low (historically). The interest rates follow inflation rates. Higher interest rates means low house price. Wages are typically the last to go up in an inflation cycle, while interest rates responsed quickly. With unemployment at >10%, higher wages are not likely even with moderate inflation. Thus decreased SOL.
If one is disciplied in saving the premimum between Cost of Ownership and Renting, it can be sizable. My wife wanted to buy in 2004. The COW without repairs would have been $5250 (Int & property tax only) vs. $2600 rent. About $2000 saved per month including income tax benefit from owning when AMT’ed. That house when up to 1.2 million and have come back down to $900,000.
Owning helps many people with forced saving on the monthly principle. Most people can’t resist spending the savings, but then they benefit by spending the saving on the goods and service.
I think both house price and rents will be going down. House price likely at a faster rate until a new rental parity target is reached.
Exactly; you had the option of paying over $2,000 per month (plus down payment and prinicpal payments) to, in essence, place a bet that an asset priced at $1 million would appreciate, over a given period of time, at a rate of more than your $2,000 per month excess cost (plus opportunity cost on down and principal payments). Why did many people make this bet? The miracle of leverage is that, the more one borrows, and the smaller the down payment, the higher one’s IRR on the investment is; all the upside is yours, if the investment tanks, you walk away. If one ignores that we were in a bubble economy in 2005 that might seem like a bet worth taking; it becomes even more compelling if one finances the entire amount and doesn’t care about destroying one’s credit. The real driver of the no-mortgage-down frenzy was the moral hazard of being able to walk away from an underwater mortgage…the possibility of having to pay back the loan was apparently not considered to be a sigficant concern by many borrowers.
I think that if we could find a fixed point in time where real estate is fairly priced, it is a reasonable assumption that RE prices will rise, over time, along with inflation, with some adjustment for the cost or ease of borrowing and the perceived increase or decrease in the quality of the neighborhood. As always though, that assumption depends on a host of inputs that seem reasonable, but are not guaranteed. If the financial crisis taught us anything, it is that everyone assuming ‘reasonable’ assumptions is a sure formula for disaster.
I actually ran my own numbers and scenario for a $300k house with an FHA loan at 6.5% 30y fixed (rent at $1875/mo), both increasing by 2% a year. I used the IHB way of calculating costs so PITI+HOA+1.5%replacement fees-tax break, etc…
Buying and selling at the end of year 7 (84 months) netted you a total cost of living in an owned home at $92k (profit from sale ($75k, includes equity in home from mortgage pay down) – cost of 7yrs mortgage payments – 7% transaction costs). Renting for 7yrs at rental parity, increasing by 2% was $167,271.
So, breaking it down, buying a home at rental parity and selling it after 7yrs with 2% appreciation for both rents & property value means you pay $1104.66/mo net owning, $1991/mo net renting (average).
I’m wondering if my numbers/methodology are flawed, I should post the spreadsheet I made (took an amortization table and added other junk).
One of the problem with rent versus own calculations where time is involved is properly discounting the figures.
Try reading Timing Does Matter. or Investment Value of Residential Real Estate
http://www3.signonsandiego.com/stories/2009/jul/20/us-home-buying-frenzy-072009/
They’re brewing up a fresh batch of kool-aid…
One of the unique qualities of Irvine seems to be its public schools. When I talk to my Asian friends I am often surprised by their willingness to pay a “premium” to buy a house in Irvine if they have school age kids. Many people I talked to said they had no problem paying 20% more than they would on a similar house in Mission Viejo, for instance. Not that MV has bad schools – but elementary/middle schools in Irvine somehow enjoy a reputation of superior quality to schools in surrounding areas. I know this is probably just a perception. But the perception has been a major factor, IMHO, driving many Asian families to Irvine. And many of them are savers with ability to put down large amount of cash. It baffles (and amazes) me that people would be paying $100K more on a house in Irvine so that their kids can go to an arguably (marginally) better school. But I do know for a fact that in some large cities in China, e.g., an apartment unit can sell for 30% higher than an identical apartment across the street, if the apartment on this side of the road happens to fall in a better school district. It’s quite natural for people with this social/cultural background to place the same value judgment when it comes to buying houses in OC.
And the question is – will Irvine continue to command a “school premium” and enjoy stickier prices over some of the equally desirable places in South OC: MV, AV, Tustin….if school is taken out of the equation?
Yes. Irvine schools have higher test scores than other nearby districts, not because the schools are anything special, but because they got a rep for having good schools, so all the parents who were extremely active in their kid’s education purchased overpriced houses there-and if a kid’s parents are extremely active in their kid’s education, chances are that kid will score well on standardized testing. If enough people believe a certain school or school district is superior than others, it will become so, because the kids with the most actively involved parents will all go out their way to send their kids there-it’s a self-fulfilling prophecy.
Once the reputation of having better school is established, it becomes a positive feedback loop that attracts students with parents more actively involved with their education, which leads to higher test score, which in turns attracts more students with dedicated parents. So the school premium on Irvine housing price continues to escalate as the feedback loop grows. But I think this premium should be capped at the level where it is roughly equal to the money spent on a private school with equivalent quality.
avobserver,
I currently have a house in Irvine (bought back in 2000). I have to say the premium people would pay for houses which went to the highest ranked schools within the Irvine school district was even crazier.
Back around 2002-2004 I had a half dozen handwritten notes left on my door asking me to sell the house to them because my house was zoned for University High and that was their top requirement. Mind you I was not on the market. They were not too concerned with the condition of the home and they stated they were willing to pay above market for it. I was not interested in selling so I never called them.
I know others have received notes on their doors in other areas during that crazy time but the notes left on my door usually noted the school was the biggest reason for wanting my house. Not sure what they would have been willing to pay for that school….
University High is a nationally ranked school. It’s always on the top 100 lists for the entire country. Many Asians from other countries rent their kids an apartment over in Turtle Rock so they can attend Uni.They actually leave the kid here alone to go to Uni. This has been going on for many years.
Very interesting. I wonder why soliciting notes stopped after 2004. You would think potential buyers might be trying harder in a down market.
It is probably not going too far to say that it is Asians and Asian Americans (specifically, Chinese Americans and immigrants from Taiwan) who have really driven the market in Irvine over the past 10 years; their children keep the school test scores up, which in turn enhances the reputation of the school, which keeps property values up. If the perception of Irvine schools eventually declines to the level of the surrounding towns, the real estate prices will decline right along with the test scores. This, again, is another one of those inputs that is so difficult to rely on.
The value of the input of having good schools can probably be computed by comparison with the alternative of sending one’s kids to private schools multiplied by the number of children (or portion of a child) in an average household at a given time.
Compare the rents in Turtle Rock vs. San Anna. There will be a rent premium in Turtle Rock and a house price premium. The house price premium is much higher than the rent premium. Same is true for Tustin USD and Irvine USD across the street.
Amazing last year on new development salesman recommended that I don’t buying in his homes because of the poor high school. The new high school would likely be completed in 10 years or more because of the govt. spending problems. I appreciated his honesty.
Usually good schools have more involved parents and less burned out teachers. Usually one conference with the parents takes care of disciple problems in the good school. Also maintenance cost are usually much lower in good schools than in bad schools, so the money can be spent on teaching and other programs.
How about labor mobility? As in you were able to take a job in a new place during tough economic times.
Speaking from experience here. Not sure, but I don’t think my company would have subsidized a loss on a home in LA to get me to Dallas. They seemed happy for me when I told them I was a renter. Deep down, they were probably relieved about not having to deal with selling difficulties or losses. Even with no subsidy, they would still know an offer would be less likely to be accepted, and if accepted, the employee would have been more distracted and in worse financial condition due to the move.
Imagine being an employer that convinced someone to take a $100k loss on their house and move for a new job. Then, because of economic turmoil you have to lay them off a few months later. Probably wouldn’t have happened at my new employer, but I’ll bet it’s happened recently at a lot of other places.
Many companies along with the employees are suffering from the impact of today’s economic hit; jobs loss, lowering sales, dropping profit, and many more. You sound philanthropic when giving those in-trouble people a living. I wish your pray would be answered. From Home Staging Service Professional