When analysing the housing market I think you must always consider how illiquid it is. This illiquidity helps keep the up market going far longer than everyone expects but in the down market you always have backed up stock that gets dumped on the market in unexpected clumps as people give up waiting for prices to rise or when a city has a round of job loses. Often prices can stabilise for a few months or even a couple of years only for them to start falling again.
In the uk prices fell 10% in the early nineties but it took 5 years for it to happen (89 to 95). Several times the bottom was called only for another round of selling to drive prices lower :(
aac74
· 1 year ago
Because of the liquidity it's almost impossible to have a bear stock market last more than 3 years. This is not the case for property where a sustained down market could easily last 5 years or more. I would say the smart money will not return before 2012 to property.
Even if inflation goes off like a rocket I don't see property prices keeping pace and thus you are loosing money. In the 70s in the UK property prices were rising 5% while inflation was double digit. Thus property was not seen as an investment opportunity.
Gold, construction stocks, utilities and asian stocks all look to be better bets for the medium to long term.
fredwilson
· 1 year ago
Right, but it depends if you are in it for appreciation or yield
MassMan
· 1 year ago
Fred,
What a wonderful question to ponder.
IMO, the outlook for home prices is grim. I suspect we are only halfway home (no pun intended). A couple of things to consider:
1) Through Sept., home prices had fallen an average of 22% from their peak in 20 major metropolitan areas 2) Home prices are still well above there histprice trend line 3) Margnal buyers have no access to creditas banks tighten lending standards 4) 2009 is going to be an economic train wreck 5) Mortgage rates are only falling for those mortgages that can be sold to the govt (via fannie and freddie) 6) Defaulting prime loans, primarily Option ARMs, home equity lines of credit (HELOCs) will be the next shoe to drop 7) Losses in commercial real estate willl further hinder mortgage lending
As I said, grim.
Mass Man
fredwilson
· 1 year ago
Agreed. But if you can invest 40k and get 10k per year in income, then I'll take that deal regarless of where the market is headed
aac74
· 1 year ago
but what if the capital loss on the property (due to the greatest depression) is $10,000 / year ? Obviously you wouldn't take this hit if you didn't sell but if you are looking for a five year investment it's high risk.
Hasn't property investment always been a capital gain rather than a yield play ? I think American thinking hasn't yet adjusted to the notion that property prices can fall for years and years. In that environment your gearing is burning your money as fast as the rental cash is coming in. So you are locked in waiting and waiting for prices to start rising.
However if you think hyper inflation is on the way the smart way to play it is to buy as many properties as you can and let inflation burn away your dollar dept while you are left with real assets.
fredwilson
· 1 year ago
It¹s like owning a bond, mark to market doesn¹t matter if you are prepared to hold to maturity
Shivering Timbers
· 1 year ago
Market prices matter a lot if housing prices generally fall in your area, letting other people buy up housing stock and undercut your rent. Rents may be more stable than purchase prices, but they will adjust to market forces every few years when you have to find a new tenant.
fredwilson
· 1 year ago
Excellent point
Paul May
· 1 year ago
We're already seeing a variant of this in Austin...it's not being driven by investors buying up inventory, but rather by homeowners that are giving up on attempts to sell their homes and putting them up for rent. There's not huge downward pressure yet, but it's definitely getting more competitive. One of our units that has historically been very easy to rent out sat for six weeks until we dropped rent by about 10%. We've owned the property since 2001, so we're still in good shape, but if you bought into the market now, you could easily see a hypothetical 25% yield turns into a loss (in Austin, a decrease in rent of less than 20% would probably do it, assuming you're incurring management fees).
ajay mishra
· 11 months ago
and then there is also, maintenance costs associated with renting the house..
I own a house in austin since 1998.. and have been renting since 2001...sometimes the house had to sit for a month before it gets a tenant.. [ this usually happens when the prior lease expires] - . but of course there is a seasonal factor involved too.. [ school starts 3 weeks from now.. better have the house in *move-in-condition*]
the-desert-dweller
· 11 months ago
Unfortunately your numbers, and thus your entire thesis, doesn't correlate to the real world! The logic makes sense but the data is way off, there is no way a home that sells for $200K would take in $2K a month on rent! Out here, in the SW U.S. a home that's valued at $200K would be lucky to rent for $1K per month. Right now I could rent a 1800K SQ home for $900 7 probably get a free month or 2 on a signed lease. And most important of all, the easy credit fueled the artificial price inflation in the first place. That is not going to happen again, at least not in our investing lifetimes so once the market settles on the real value you are looking at dead money in terms of appreciation, maybe a few points a year for a very illiquid asset.
The bottome line, the average home will soon become simply a place to live, not get rich so we will stop deflating at some point, mabye get a bounce off the bottom and them settle in for a long slow flatline in relation to overall inflation, etc.
eliafreedman
· 1 year ago
You make some interesting assumptions. First, you're assuming the family renting can come up with $40k as a down payment. Frankly, in my conversations with renters and Realtors, the down payment is one of the big reasons keeping people renting. Next your assuming they can get an interest-only mortgage. Good luck with that! It's hard enough finding a fixed-rate mortgage let alone an interest-only one. And third, you left out all the other costs of home ownership in your analysis (taxes, repairs, etc.) when you included (at least part of) them in your rental analysis. Finally, at least on the west and east coasts of this country, $200k doesn't buy you anything worth re-renting. Here in Portland, Ore., (still the least expensive major city on either coast) $300k gets you started.
Dan Cornish
· 1 year ago
You neglect to take into account a few things. 1. The cost of the property remaining empty between rentals, you assume a 100% rental rate, so you have to assume that the property will be empty 10% of the time due to poor market conditions. 2. Increased property taxes to pay for all of the new services - assume a 20% increase in the next two years 3. Bad debt - some renters will not pay rent 4. Continued reduction in real estate values - this will naturally put pressure on rents to move down so the rental rates you get this year may have to be reduced next year 5. Damage to the property - each time you rent the property the landlord typically has to make repairs which are not covered by the deposit. A bad tenant can cause very expensive damage which can not be recovered 6. Unexpected repairs, sometime major costs like furnace, pipes, electrical, etc..
The point is that the real returns for real estate are much lower than the back of the envelope returns. Also only experienced investors should be investing in real estate, and most of those are tapped out due to the difficulties with existing investments. There is no quick fix here and the bottom will be a lot more difficult to find this time around. After the market crash in 1987, real estate values did not start going back up in some markets until 1993-94, six to seven years after the market crash.
dfriedman
· 1 year ago
I have an acquaintance who set up an investment fund based on this theory: buy houses and rent them to tenants. Suffice it to say his fund is being unwinded as we speak.
While your theory is interesting it's not realistic. You do not account for maintenance, insurance, taxes, and other costs that come with owning a house. A house is not like a basket of stocks: its carrying costs are far greater and those costs retard the return on investment.
That said, there is an unquantifiable benefit than some people see to owning their own home, which benefit should not be excluded from the analysis.
fredwilson
· 1 year ago
That¹s all true, but I did include the cost of taxes and maintenance in the cost of owning as a landlord which was my point
ajay mishra
· 11 months ago
ok sorry Fred yes.. you did but you missed the following :
[1] occupancy rate is rarely 100% { your analysis assumes 100 % occupancy]
[2] default { or expected probability of default} - as ion renters not paying their rent - on time and/or in full
awatterson
· 1 year ago
It's interesting that you talk about the "unquantifiable benefit than some people see to owning their own home." While I don't disagree. Isn't that the theory/justification for the gov't allowing such risky lending practices and standards.
dfriedman
· 1 year ago
I don't think the government or anyone who works for it is sophisticated enough to converse about the unquantifiable benefit that some people see to owning their own home; that said, yes, there is an implicit assumption in various tax and mortgage policies promulgated by the government that spread home ownership to those least able to afford it.
It would seem to me that relatively few Americans should own homes, just as in other countries. Say 30-70 or some split like that. But the notion that government policy ought to encourage 60+% of Americans to own a home is ludicrous.
awatterson
· 1 year ago
I completely agree. However, I don't think that the tax and mortgage implications and benefits are the (main) issue. It was congress and the executive branch making Fannie and Freddie's mission statement to increase home ownership at the implicit disregard for the ability to pay that was a betrayal and gov't mismanagement.
Giving tax breaks eases the cost of home ownership, but it only marginally (if at all) contributes to the lax and irresponsible lending standards that built this mess.
dfriedman
· 1 year ago
Giving tax breaks on mortgage interest only serves to prop up the prices of homes because it allows borrowers to use leverage and sellers to demand higher prices. Note there is no "tax savings" in the mortgage interest deduction: you are merely paying in interest what would have otherwise been paid in taxes. You are not saving money in any real sense, despite all the rhetoric about same.
aleax
· 12 months ago
The "unquantifiable benefits of owning my home" can definitely be very large (depending no doubt on detailed cultural issues about what the landlord gets to forbid his tenants and what he doesn't), for example by owning I get to decide how many pets of what species and breed I choose to have, whether I smoke in the house, what color I can paint the interior walls tomorrow, whether I'm going to keep using that old dishwasher or upgrade e.g. to a new model that saves water and electricity, can I have a friend sleep over on the couch for a couple of nights, and so forth.
Each of these freedoms of choice are often denied by at least most landlords in many parts of the US and some other countries. I suspect that in countries where the vast majority of people of all social classes rent, such as Switzerland, the landlords, typically insurance companies, just don't get to micromanage their tenants' lives to such an extent, be it by law or unwritten cultural custom -- making the benefits of ownership much lesser.
Some US localities are starting to restrict renters' freedoms *independently of the landlord's wishes* -- in Belmont, CA, starting tomorrow, you can't smoke at home if you rent, period (you can still smoke if you own the house you live in, for now -- you can't smoke anywhere else in town in either case); indeed some landlords were (futilely) protesting this new law back when it was passed (just like owners of restaurants and bars have routinely, and just as uselessly, protested against mandated smoking bans in their establishments in the past).
aac74
· 1 year ago
You also have to take into account that unlike a stock (where you can get a real market price anytime you want) you are never completely sure of the price of your property (and therefore the return on your investment) until you find a buyer !
howardlindzon
· 1 year ago
it was cheaper to rent than buy since 2004 and the housing market kept going up so who the hell knows.
fredwilson
· 1 year ago
Right, but that kept landlords out of the residential market because you couldn¹t make money owning a home and renting it
I think that¹s changed and that was the point of my post
howardlindzon
· 1 year ago
what hasn changed is all the developers moving into the rental space and the upgrades coming for renters and incentives.
brad northrop
· 1 year ago
let's not forget this is an asset bubble popping.
So, you have an auto-loan bubble popping. And a credit card bubble that has yet to pop. And a commercial real estate bubble that will pop next year. And you have a wave of alt A mortgages that will reset in the next couple of years, further depressing the housing market.
By the time you're done with this financial mess, there's the HUGE social security deficit to tackle.
fredwilson
· 1 year ago
That¹s all true, but investors with cash need to put it somewhere other than a mattress and families need a roof over their head.
I¹m just thinking outloud about where there are investable assets in 2009 and I think this is one good place to look
aac74
· 1 year ago
Another thing to consider is that in most countries if you are underwater on a mortgage and you sell you get chased for the dept. In the US the bank takes the hit and just lets you walk away.
This is a very strange version of free market capitalism and has created so many problems there can be no way it can continue ? In the mean time if you can still get this deal you should be buying every house you can find.
Thus the US thinking on property investment is very different to that on planet earth (i.e you can't loose !)
Shivering Timbers
· 1 year ago
The market was irrational on the way up. Why would you assume rationality on the way down?
To be a bit less glib--your analysis assumes that (1) financing is available for the investment homebuyer, when market reality suggests otherwise since non-owner-occupied housing is one of the new red flags for mortgage issuers; (2) there is a large enough pool of investors interested in becoming landlords to soak up the housing stock, even though being a landlord is a pain in the nether regions and much different than investing in stocks or bonds; and (3) those interested in becoming landlords who are able to get financing believe that the market is close enough to a bottom that they won't lose their shirts by buying now.
Personally, I'm optimistic that we're close to a bottom. On the other hand, I've felt that way since June, and I'm starting to come to grips with the fact that the markets don't much care how I feel.
grinch
· 1 year ago
hold to maturity bullshit? and then what? take a 40% haircut on the $20m you dropped on a declining market like NY? do you even know what a bond is?
sonny, you've come a long way in life by the way you make your investments in the real world. stick to start-ups, there you might still find your suckers.
fredwilson
· 1 year ago
Sonny? That¹s a new one.
Actually you never have to sell a real estate investment, there is no maturity
And where¹s the $20mm figure coming from?
kidmercury
· 1 year ago
grinch's comment would've been a lot more amusing if his screen name was sonny. but instead he's some punk ass chump who doesn't even have an avatar making unwitty comments, most likely because he's jealous of you. as a result, i think it's safe to say we can chalk another one up in the victory column for fred, as fred clearly wins this beef against the infinitely lame and cowardly grinch. congrats on your victory, fred. although this one was pretty easy, kinda gift wrapped for you in light of the grinch's inherent and obvious weakness as an individual. and while grinch is obviously objectively inferior to you i do have to hate on you fred just a little bit for always being polite and civilized, it would be a lot more fun if you rubbed it in that you were richer and more successful.
with that said grinch does appear to have an iota of intelligence (proof that miracles do happen), as the bottom in housing is years away. if housing prices rise the value of the dollar will fall even more, so it will still yield negative real returns. long-term dollar-denominated investments remain the worst of all investment opportunities (with the exception of some private companies that have great management that will be able to survive and grow over the long-term).
fredwilson
· 1 year ago
Kid - merry christmas, chanukah, or whatever floats your boat. Its people like you who keep this blog entertaining and interesting. I'm not subscribing to any of your theories just yet, but you make me think and that's a gift. Thanks
titocosta
· 1 year ago
That's an interesting analysis. I'll share what the situation is in Milan downtown, where prices have not really started falling yet. Excluding premium neighborhoods where house prices have reached €8k-10k per sqm (or about $1k-1.25k per sqf), an average house sells at a price of about €4000 per sqm. The same house can be rented at €16-20/sqm per month or €240/sqm per year for a 5-6% yield (gross of any tax and maintenance).
In order to reach a 9% yield, house prices will have to fall to about €2500 per sqm or about 40%. In doubt, I think I'll wait.
MartinEdic
· 1 year ago
You didn't mention depreciation. When I was a landlord years ago you could write off 1/18 of the value of the property each year for 18 years. I believe this has actually been shortened. Landlording is not an investment though, it is a job or a business depending on your perspective. Also, typically rents go up during a recession and down during a bubble because of tightening credit and job losses during the recession. There is little incentive to own if you don't have cash, can't get a loan and don't have income to take your mortgage deduction against. I have a close friend whose company builds and manages rental properties (1000s of units) and their business does well during times when there are housing problems. BTW, he is involved in banking and 18 months ago, over dinner, he detailed exactly where he saw things going. It was a scary scenario and he was 100% correct including the timeline. And he has zero confidence in Paulsen.
ckstevenson
· 1 year ago
The Case/Schiller index says we have a ways to go.
The last thing you'd want to do these days is get an ARM or an interest only loan. I'm not even sure you can do that for a rental property either. Given how low rates are, the safest thing to do (especially since posters above have shown your yearly profit cals to be a bit overly optimistic) is to get a 30 year fixed.
It is VERY hard to find a property that is profitable on a monthly/yearly basis. Typically the profits are in the 1-5% range, if at all profitable. Your best bet is to find a property that should rebound well, hope the rent can cover the mortgage, and make wise upgrades to it later on.
You should also consider the management factor. Do you want to be doing credit checks? You better do them in this market. Do you want calls at 4am when a toilet is leaking. Or during dinner when the oven or washing machine don't work? You can assume a management company fee who will do all of that for you.
druce
· 1 year ago
To yield 9%, a $1m NY apartment would have to rent for 7,500 per month ABOVE the maintenance/common charges.
On the plus side, zero interest rate policy will help, plus New York prices never got quite as insanely out of line with incomes as some other places.
On the negative side, the local economy will be very hard hit by Wall Street, rents are coming down and taxes will be going up (both property and income).
I don't think we're close to rent parity yet and wouldn't be buying without a likelihood of future appreciation.
In the very long term you want to own property in an inflationary environment which is inevitable due to demographics, international factors, but right now there's a deflation meme going around. Eventually you'll be right but you're (really) early.
fredwilson
· 1 year ago
I really wasn¹t thinking about NYC when I wrote the post
I was thinking of anywhere really
druce
· 1 year ago
where is the $200K /$2000 example available? I don't really think we've gotten there yet.
my example illustrates factors that would apply anywhere... how overpriced did homes get, resulting in how much overbuilding, which will in turn cause how much overshoot to the downside, and how much worse will the local economy get.
a Brooklyn building I'm familiar with went co-op around 1985, one-bedrooms went for around $150K. Fast-forward to 1994, those apartments were offered in the $60K range with few takers. At that time it was clearly cheaper to own than rent.
my gut tells me real estate will bottom a year before the economy bottoms and you'll see real fire sale prices and capitulation and your math will work. The real consumer downturn is just starting and I haven't seen people really throw in the towel or that math kick in.
fredwilson
· 1 year ago
That's a good question drew. Where is the 100/1 ratio (purchase price/monthly rent) actually available?
I don't know and don't know how to easily use the web to find it. But I am sure you can use the web to find out
druce
· 1 year ago
at 3% after tax cost of capital (5% mortgage rate, 40% marginal combined tax rate)
the monthly rent / house price multiplier is 400 : 12 (months) / .03
but you have back out of the rent the included costs (property taxes, maintenance, insurance) you will be buying the right to pay.
so on a house with $1,000/month expenses, $200,000 purchase price works out to $1,500 a month rent.
assumes no transaction costs, house appreciation, changes in costs or rent over time
given the recent excesses I'd be surprised if the bottom wasn't even uglier than in 1994 and I don't think we got to parity yet.
jeremystein
· 1 year ago
you also get a tax shield from the interest on the mortgage, so you get a slightly better return than 25%. depending on tax brackets it can make a significant difference.
Facebook User
· 1 year ago
I think is there is some more to go. I have not really seen prices falls enough, especially in the area of NJ that I live. Prices are still way too high around here. I think we have some room before the bottom comes up.
Josh
· 1 year ago
Fred, Take a look at this clip from 60 mins...http://www.cbsnews.com/stories/2008/12/12/60minutes/main4666112_page2.shtml
The gentleman they interview gave a pretty convincing presentation on the coming second wave of the housing collapse. This is because the Alt A and Option ARM loans have not reset yet...and there is a larger portion of those loans than there are subprime. We could be years away from a bottom (4-6).
Fred - love your blog but don't get your numbers. I can't imagine someone paying $2,000 per month to rent a home that sold for $200,000. First of all a 200k mortgage at 6 percent (including 6k in taxes, insurance, maintenance) is $1,700 per month. Your prospective renter will buy next door instead of renting from you. I'll give you a real world example. Houses in my neighborhood range from 190k-280k. I pay $1,100 per month in rent, which is a pretty good deal but within the average for the area. (My landlord bought the house before the boom). I'm about to renew the lease and rent is not going up.
fredwilson
· 1 year ago
Thanks Isaac. This was a thought exercise to figure out when housing will bottom. I bet there are some places where the 100/1 ratio is coming into place. I just don't know where it is. But when it happens, I think we'll see a bottom for exactly the reasons you outline. It could happen at 12/1 or maybe even 14/1 depending on mortgage interest rates which are at historical lows
marcusellison
· 12 months ago
Hi Fred,
It is my estimation that an absolute bottom to housing prices as well as rentals runs in line with general housing affordability. One of the most fundamental drivers of value, and of which all great enterprises I can think are based, lies in solving needs better. In housing the need satisfied is a place to live that is not too far from where income is generated. Consequently, the greatest indication of aggregate housing demand is net population growth/decline in a given area because it suggests how the number of people in an area changes over time. Yet, this demand (at a given price point) is limited by those who have the income to justify the housing expense. Over the last decade (and probably much longer) average incomes have remained stagnant or decreased in relation to inflation. At the same time, debt has increased substantially, decreasing purchasing power.
When looking at the underlying value of purchasing a property for rental income, the bottom of the market is the price at which the need satisfied (housing) is reasonable to the average individual. Across any income it is generally regarded that spending 30% of income is an affordable amount to be spent on housing.
So, if you're renting a unit for $2000/month your tenants should be making at least $72,000 per year.
As an investor you want to know both how many people would consider your unit "affordable" and what your competition is that could potentially decrease your profit margins.
Essentially, putting all this together, the bottom of the housing market will arrive when housing prices fall back in line with increases in income (for the given demographic your looking at). For the average house or apartment there is still some way to go, but by buying at a price at which the property can be rented with strong demand you can predict an appropriate margin of safety.
fredwilson
· 12 months ago
This is such a great point. I assume there is census data that could be accessed to spotlight where housing may have reached this level
val_popov
· 1 year ago
This is a very interesting discussion, so here are my 2 cents. The cure for low prices are low prices, just like the cure for high prices are high prices. I didn’t come up with this, but heard it somewhere and thought it was cool. I agree with Fred that there is a price level that will get all kinds of buyers to come back to the market. The question is whether this price level has arrived. Market bottoms occur when sellers capitulate. With 11 months supply of unsold homes in November compared to 10 months supply in October, it doesn’t seem like sellers have thrown in the towel just yet. A big chunk of the supply are foreclosures. Until the forced selling by banks ends, we will not see a bottom to the housing market. What lenders should do is start slashing prices at the margin, in an effort to sell properties as quickly as possible. This will give a signal for buyers to come back, and we may actually see a rebound in home prices, which will bring even more buyers. The fact that mortgage rates are at historic lows around 5% should help as well.
Ironically, there is tremendous pressure on lenders to avoid foreclosures through loan modifications. Also, there is strong regulatory support for bankruptcy reform to allow mortgage modifications in bankruptcy court. Unfortunately, a recent OCC report shows that more than half of the loans modified in the first half of 2008 are delinquent again. Counter-intuitive as it may seem, foreclosure prevention efforts run the risk of simply postponing the foreclosure. This will stretch the bottoming process and delay the recovery. Lenders should carefully examine their loan modification efforts to make sure that the modified loans are viable. Recent streamline modification programs by the FDIC, FHFA and some big lenders that focus on affordability are steps in the right direction.
As to the discussion of the importance of rental income, it is hard for me to comment since I am not familiar with rent levels across the country. It does seem to me, though, that this is somewhat similar to dividends and stocks. If you are looking at a low growth stock, dividend is important - that's what housing used to be; if you are looking at growth stock, you don't care about dividends - that was the housing bubble; if you are looking at a rapidly declining stock, investors shy away regadless of dividend, since nobody wants to catch a falling knife - that's the housing market of today. Once we reach price stability though, rents should be important once again.
So, how do you tell that the housing bottom is near – keep an eye on the months supply of unsold homes and the success rate of loan mods. In the meantime, we may see some ridiculous prices…
In your yearly carrying costs shouldnt you include mortgage payments made over the year (and specifically the $ used towards paying interest since there is no 'value' to that) ?
fredwilson
· 12 months ago
I included interest payments but assumed it was an interest only loan for purposes of simplicity
Also, one could argue that principal payments are not a cost because they are building equity
deepeshbanerji
· 12 months ago
Arguable interest payments are a nonfactor since you can use as deductions on income tax owed
DD
· 12 months ago
We rent a house in Montecito, CA (very close to Oprah's house) for just under $4000/month. This house is worth approx. $2.4 million currently. The monthly payment to purchase this house would be approx. $13,000 / month !!
There are many markets where housing prices will have to come WAY down before your scenario will make anyone any money.
fredwilson
· 12 months ago
Yup. And the problem is worse at the high end of the market.
CPA
· 12 months ago
Unless you pay it in cash, you never really "own" a home. The bank who lent you money owns it, and then the state owns it, i.e you have property taxes to keep paying until you die and if you don't pay them, you are in foreclosure. In states like New Jersey, property taxes are ridiculously high, say $20,000 for a $600,000 house. Better to rent.
Also you have a lot of maintenance to pay in a house that you didn't take into account: new appliances, heater, air conditioning, gardening expenses, contractors charging you a few thousands to change a water pipe or a tile on the roof and so on. When you rent, you don't need to care about all this.
Owning a house gives you this false sense of security of "ownership" but you don't really own anything. Banks and brokers love these high prices! You are better off renting now until prices go back to realistic levels.
It's really no
aleax
· 12 months ago
"In states like New Jersey, property taxes are ridiculously high, say $20,000 for a $600,000 house. Better to rent."...??? How can property taxes ever make it "better to rent" (or, for that matter, worse)?!
Just as, at equilibrium, all corporate taxes must be reflected in the prices the corporation sells products or services for (since nobody would run that corporation at a loss forever), just so property taxes must be reflected in rents -- so if an identical house sells for the same $600k in two localities, and in one it pays $20k in property taxes while in the other it pays $10k, then inevitably it will rent for $10k more in the first locality.
For a transient period after *unanticipated changes* in taxes and other regulations, some investors may get soaked (or may get a windfall, of course) -- some regulations (such as rent control) may stretch out the time needed for adjustment (so you might be well advised to keep renting a rent-controlled unit if you're lucky enough to live in one -- even if it falls apart as the landlord obviously fails to invest in it) -- but if you're moving to NJ today, and only deciding whether to rent or buy, property taxes MUST be immaterial to your decision.
Laurie Miller
· 9 months ago
Seems like a good deal for investors, but what about the people who need to live in the homes and can't get loans ... and have a really hard time qualifying for rentals too because their credit's bad.
I like the idea that the housing market might be coming back ... but it sounds like its coming back as an investment, not providing places for people to live. When you're dealing with clients who need a place to live, be it a purchase or a rental, it still seems like the housing market still has a long way to go before it makes a real comeback.
All Comments
In the uk prices fell 10% in the early nineties but it took 5 years for it to happen (89 to 95). Several times the bottom was called only for another round of selling to drive prices lower :(
Even if inflation goes off like a rocket I don't see property prices keeping pace and thus you are loosing money. In the 70s in the UK property prices were rising 5% while inflation was double digit. Thus property was not seen as an investment opportunity.
Gold, construction stocks, utilities and asian stocks all look to be better bets for the medium to long term.
What a wonderful question to ponder.
IMO, the outlook for home prices is grim. I suspect we are only halfway home (no pun intended). A couple of things to consider:
1) Through Sept., home prices had fallen an average of 22% from their peak in 20 major metropolitan areas
2) Home prices are still well above there histprice trend line
3) Margnal buyers have no access to creditas banks tighten lending standards
4) 2009 is going to be an economic train wreck
5) Mortgage rates are only falling for those mortgages that can be sold to the govt (via fannie and freddie)
6) Defaulting prime loans, primarily Option ARMs, home equity lines of credit (HELOCs) will be the next shoe to drop
7) Losses in commercial real estate willl further hinder mortgage lending
As I said, grim.
Mass Man
Hasn't property investment always been a capital gain rather than a yield play ? I think American thinking hasn't yet adjusted to the notion that property prices can fall for years and years. In that environment your gearing is burning your money as fast as the rental cash is coming in. So you are locked in waiting and waiting for prices to start rising.
However if you think hyper inflation is on the way the smart way to play it is to buy as many properties as you can and let inflation burn away your dollar dept while you are left with real assets.
to hold to maturity
I own a house in austin since 1998.. and have been renting since 2001...sometimes the house had to sit for a month before it gets a tenant.. [ this usually happens when the prior lease expires] -
.
but of course there is a seasonal factor involved too.. [ school starts 3 weeks from now.. better have the house in *move-in-condition*]
And most important of all, the easy credit fueled the artificial price inflation in the first place. That is not going to happen again, at least not in our investing lifetimes so once the market settles on the real value you are looking at dead money in terms of appreciation, maybe a few points a year for a very illiquid asset.
The bottome line, the average home will soon become simply a place to live, not get rich so we will stop deflating at some point, mabye get a bounce off the bottom and them settle in for a long slow flatline in relation to overall inflation, etc.
1. The cost of the property remaining empty between rentals, you assume a 100% rental rate, so you have to assume that the property will be empty 10% of the time due to poor market conditions.
2. Increased property taxes to pay for all of the new services - assume a 20% increase in the next two years
3. Bad debt - some renters will not pay rent
4. Continued reduction in real estate values - this will naturally put pressure on rents to move down so the rental rates you get this year may have to be reduced next year
5. Damage to the property - each time you rent the property the landlord typically has to make repairs which are not covered by the deposit. A bad tenant can cause very expensive damage which can not be recovered
6. Unexpected repairs, sometime major costs like furnace, pipes, electrical, etc..
The point is that the real returns for real estate are much lower than the back of the envelope returns. Also only experienced investors should be investing in real estate, and most of those are tapped out due to the difficulties with existing investments. There is no quick fix here and the bottom will be a lot more difficult to find this time around. After the market crash in 1987, real estate values did not start going back up in some markets until 1993-94, six to seven years after the market crash.
While your theory is interesting it's not realistic. You do not account for maintenance, insurance, taxes, and other costs that come with owning a house. A house is not like a basket of stocks: its carrying costs are far greater and those costs retard the return on investment.
That said, there is an unquantifiable benefit than some people see to owning their own home, which benefit should not be excluded from the analysis.
cost of owning as a landlord which was my point
[1] occupancy rate is rarely 100% { your analysis assumes 100 % occupancy]
[2] default { or expected probability of default} - as ion renters not paying their rent - on time and/or in full
It would seem to me that relatively few Americans should own homes, just as in other countries. Say 30-70 or some split like that. But the notion that government policy ought to encourage 60+% of Americans to own a home is ludicrous.
Giving tax breaks eases the cost of home ownership, but it only marginally (if at all) contributes to the lax and irresponsible lending standards that built this mess.
Each of these freedoms of choice are often denied by at least most landlords in many parts of the US and some other countries. I suspect that in countries where the vast majority of people of all social classes rent, such as Switzerland, the landlords, typically insurance companies, just don't get to micromanage their tenants' lives to such an extent, be it by law or unwritten cultural custom -- making the benefits of ownership much lesser.
Some US localities are starting to restrict renters' freedoms *independently of the landlord's wishes* -- in Belmont, CA, starting tomorrow, you can't smoke at home if you rent, period (you can still smoke if you own the house you live in, for now -- you can't smoke anywhere else in town in either case); indeed some landlords were (futilely) protesting this new law back when it was passed (just like owners of restaurants and bars have routinely, and just as uselessly, protested against mandated smoking bans in their establishments in the past).
couldn¹t make money owning a home and renting it
I think that¹s changed and that was the point of my post
upgrades coming for renters and incentives.
So, you have an auto-loan bubble popping. And a credit card bubble that has yet to pop. And a commercial real estate bubble that will pop next year. And you have a wave of alt A mortgages that will reset in the next couple of years, further depressing the housing market.
By the time you're done with this financial mess, there's the HUGE social security deficit to tackle.
a mattress and families need a roof over their head.
I¹m just thinking outloud about where there are investable assets in 2009
and I think this is one good place to look
This is a very strange version of free market capitalism and has created so many problems there can be no way it can continue ? In the mean time if you can still get this deal you should be buying every house you can find.
Thus the US thinking on property investment is very different to that on planet earth (i.e you can't loose !)
To be a bit less glib--your analysis assumes that (1) financing is available for the investment homebuyer, when market reality suggests otherwise since non-owner-occupied housing is one of the new red flags for mortgage issuers; (2) there is a large enough pool of investors interested in becoming landlords to soak up the housing stock, even though being a landlord is a pain in the nether regions and much different than investing in stocks or bonds; and (3) those interested in becoming landlords who are able to get financing believe that the market is close enough to a bottom that they won't lose their shirts by buying now.
Personally, I'm optimistic that we're close to a bottom. On the other hand, I've felt that way since June, and I'm starting to come to grips with the fact that the markets don't much care how I feel.
sonny, you've come a long way in life by the way you make your investments in the real world. stick to start-ups, there you might still find your suckers.
Actually you never have to sell a real estate investment, there is no
maturity
And where¹s the $20mm figure coming from?
with that said grinch does appear to have an iota of intelligence (proof that miracles do happen), as the bottom in housing is years away. if housing prices rise the value of the dollar will fall even more, so it will still yield negative real returns. long-term dollar-denominated investments remain the worst of all investment opportunities (with the exception of some private companies that have great management that will be able to survive and grow over the long-term).
In order to reach a 9% yield, house prices will have to fall to about €2500 per sqm or about 40%.
In doubt, I think I'll wait.
Also, typically rents go up during a recession and down during a bubble because of tightening credit and job losses during the recession. There is little incentive to own if you don't have cash, can't get a loan and don't have income to take your mortgage deduction against.
I have a close friend whose company builds and manages rental properties (1000s of units) and their business does well during times when there are housing problems. BTW, he is involved in banking and 18 months ago, over dinner, he detailed exactly where he saw things going. It was a scary scenario and he was 100% correct including the timeline. And he has zero confidence in Paulsen.
The last thing you'd want to do these days is get an ARM or an interest only loan. I'm not even sure you can do that for a rental property either. Given how low rates are, the safest thing to do (especially since posters above have shown your yearly profit cals to be a bit overly optimistic) is to get a 30 year fixed.
It is VERY hard to find a property that is profitable on a monthly/yearly basis. Typically the profits are in the 1-5% range, if at all profitable. Your best bet is to find a property that should rebound well, hope the rent can cover the mortgage, and make wise upgrades to it later on.
You should also consider the management factor. Do you want to be doing credit checks? You better do them in this market. Do you want calls at 4am when a toilet is leaking. Or during dinner when the oven or washing machine don't work? You can assume a management company fee who will do all of that for you.
On the plus side, zero interest rate policy will help, plus New York prices never got quite as insanely out of line with incomes as some other places.
On the negative side, the local economy will be very hard hit by Wall Street, rents are coming down and taxes will be going up (both property and income).
I don't think we're close to rent parity yet and wouldn't be buying without a likelihood of future appreciation.
In the very long term you want to own property in an inflationary environment which is inevitable due to demographics, international factors, but right now there's a deflation meme going around. Eventually you'll be right but you're (really) early.
I was thinking of anywhere really
my example illustrates factors that would apply anywhere... how overpriced did homes get, resulting in how much overbuilding, which will in turn cause how much overshoot to the downside, and how much worse will the local economy get.
a Brooklyn building I'm familiar with went co-op around 1985, one-bedrooms went for around $150K. Fast-forward to 1994, those apartments were offered in the $60K range with few takers. At that time it was clearly cheaper to own than rent.
my gut tells me real estate will bottom a year before the economy bottoms and you'll see real fire sale prices and capitulation and your math will work. The real consumer downturn is just starting and I haven't seen people really throw in the towel or that math kick in.
I don't know and don't know how to easily use the web to find it. But I am sure you can use the web to find out
tax rate)
the monthly rent / house price multiplier is 400 : 12 (months) / .03
but you have back out of the rent the included costs (property taxes,
maintenance, insurance) you will be buying the right to pay.
so on a house with $1,000/month expenses, $200,000 purchase price works
out to $1,500 a month rent.
assumes no transaction costs, house appreciation, changes in costs or
rent over time
pretty slick calculator here -
http://www.nytimes.com/2007/04/10/business/2007...
given the recent excesses I'd be surprised if the bottom wasn't even
uglier than in 1994 and I don't think we got to parity yet.
Take a look at this clip from 60 mins...http://www.cbsnews.com/stories/2008/12/12/60minutes/main4666112_page2.shtml
The gentleman they interview gave a pretty convincing presentation on the coming second wave of the housing collapse. This is because the Alt A and Option ARM loans have not reset yet...and there is a larger portion of those loans than there are subprime. We could be years away from a bottom (4-6).
Here is a link to the presentation: http://www.valueinvestingcongress.com/downloads...
It is my estimation that an absolute bottom to housing prices as well as rentals runs in line with general housing affordability. One of the most fundamental drivers of value, and of which all great enterprises I can think are based, lies in solving needs better. In housing the need satisfied is a place to live that is not too far from where income is generated. Consequently, the greatest indication of aggregate housing demand is net population growth/decline in a given area because it suggests how the number of people in an area changes over time. Yet, this demand (at a given price point) is limited by those who have the income to justify the housing expense. Over the last decade (and probably much longer) average incomes have remained stagnant or decreased in relation to inflation. At the same time, debt has increased substantially, decreasing purchasing power.
When looking at the underlying value of purchasing a property for rental income, the bottom of the market is the price at which the need satisfied (housing) is reasonable to the average individual. Across any income it is generally regarded that spending 30% of income is an affordable amount to be spent on housing.
So, if you're renting a unit for $2000/month your tenants should be making at least $72,000 per year.
As an investor you want to know both how many people would consider your unit "affordable" and what your competition is that could potentially decrease your profit margins.
Essentially, putting all this together, the bottom of the housing market will arrive when housing prices fall back in line with increases in income (for the given demographic your looking at). For the average house or apartment there is still some way to go, but by buying at a price at which the property can be rented with strong demand you can predict an appropriate margin of safety.
Ironically, there is tremendous pressure on lenders to avoid foreclosures through loan modifications. Also, there is strong regulatory support for bankruptcy reform to allow mortgage modifications in bankruptcy court. Unfortunately, a recent OCC report shows that more than half of the loans modified in the first half of 2008 are delinquent again. Counter-intuitive as it may seem, foreclosure prevention efforts run the risk of simply postponing the foreclosure. This will stretch the bottoming process and delay the recovery. Lenders should carefully examine their loan modification efforts to make sure that the modified loans are viable. Recent streamline modification programs by the FDIC, FHFA and some big lenders that focus on affordability are steps in the right direction.
As to the discussion of the importance of rental income, it is hard for me to comment since I am not familiar with rent levels across the country. It does seem to me, though, that this is somewhat similar to dividends and stocks. If you are looking at a low growth stock, dividend is important - that's what housing used to be; if you are looking at growth stock, you don't care about dividends - that was the housing bubble; if you are looking at a rapidly declining stock, investors shy away regadless of dividend, since nobody wants to catch a falling knife - that's the housing market of today. Once we reach price stability though, rents should be important once again.
So, how do you tell that the housing bottom is near – keep an eye on the months supply of unsold homes and the success rate of loan mods. In the meantime, we may see some ridiculous prices…
Here is a link to a recent article that discusses the supply of unsold homes:
http://money.cnn.com/2008/12/23/real_estate/hom...
Also, one could argue that principal payments are not a cost because they are building equity
deductions on income tax owed
There are many markets where housing prices will have to come WAY down before your scenario will make anyone any money.
Also you have a lot of maintenance to pay in a house that you didn't take into account: new appliances, heater, air conditioning, gardening expenses, contractors charging you a few thousands to change a water pipe or a tile on the roof and so on. When you rent, you don't need to care about all this.
Owning a house gives you this false sense of security of "ownership" but you don't really own anything. Banks and brokers love these high prices! You are better off renting now until prices go back to realistic levels.
It's really no
Just as, at equilibrium, all corporate taxes must be reflected in the prices the corporation sells products or services for (since nobody would run that corporation at a loss forever), just so property taxes must be reflected in rents -- so if an identical house sells for the same $600k in two localities, and in one it pays $20k in property taxes while in the other it pays $10k, then inevitably it will rent for $10k more in the first locality.
For a transient period after *unanticipated changes* in taxes and other regulations, some investors may get soaked (or may get a windfall, of course) -- some regulations (such as rent control) may stretch out the time needed for adjustment (so you might be well advised to keep renting a rent-controlled unit if you're lucky enough to live in one -- even if it falls apart as the landlord obviously fails to invest in it) -- but if you're moving to NJ today, and only deciding whether to rent or buy, property taxes MUST be immaterial to your decision.
I like the idea that the housing market might be coming back ... but it sounds like its coming back as an investment, not providing places for people to live. When you're dealing with clients who need a place to live, be it a purchase or a rental, it still seems like the housing market still has a long way to go before it makes a real comeback.