the myth of the paid-for house

[grapejelly]

Let's assume you pay down your mortgage and own your home free and clear. For many people this is a key part of their retirement plan because they figure their monthly expenses will be much lower without the mortgage and this will allow them to live on a far lower income than otherwise.

Ahh, but it doesn't work that way.

Let's take a house of, say, $224K value.

State and local taxes are destined to rise sharply because of the huge deficit in public worker pension and health care plans, if nothing else.

Taxes can be $500 per month this house, in many areas.

Add insurance at $100 per month and you are at $600 per month...but that isn't all.

You have repairs that are conservatively another $500 per month for the average house. This is low. It may be more like $800 - $1000 per month.

You have to periodically update a house meaning spend $12K on a new bathroom (very cheap) and $30K on a new kitchen. There is yard work, new roof periodically, paint, carpet and flooring, window treatments, caulking and repair of plumbing, and much more as you know.

If you do the work yourself, your time has value doesn't it? When all is said and done, the hidden costs of owning a paid-for house match the cost of renting. And meanwhile you have all your capital tied up. In fact, the hidden costs of a paid-for house can exceed the costs of renting. The big advantage the owners have is in tax savings, but if your income is low anyway this isn't going to mean as much to you.

I lived in California during the Prop 13 war. What is coming up now is more of a general revolt against state and local taxes by the middle class whose standard of living is declining. They find that even a paid-for house is no bargain.

[Sapiens]

Re: the myth of the paid-for house

You have repairs that are conservatively another $500 per month for the average house. This is low. It may be more like $800 - $1000 per month.

In practice I have found this to be on average $80 to $120 per month. In the NE U.S. for each of about 300 SFHs.

You have to periodically update a house meaning spend $12K on a new bathroom (very cheap) and $30K on a new kitchen. There is yard work, new roof periodically, paint, carpet and flooring, window treatments, caulking and repair of plumbing, and much more as you know.

If you do the work yourself, your time has value doesn't it? When all is said and done, the hidden costs of owning a paid-for house match the cost of renting. And meanwhile you have all your capital tied up. In fact, the hidden costs of a paid-for house can exceed the costs of renting. The big advantage the owners have is in tax savings, but if your income is low anyway this isn't going to mean as much to you.

You must understand the rules of the game, one of these being the holding of title. Second, you must know how to take advantage of depreciation. Third, the intricacies of mortgages as financial instruments...on and on...

[Tet]

Re: the myth of the paid-for house

Let's assume you pay down your mortgage and own your home free and clear. For many people this is a key part of their retirement plan because they figure their monthly expenses will be much lower without the mortgage and this will allow them to live on a far lower income than otherwise.

Ahh, but it doesn't work that way.

Let's take a house of, say, $224K value.

State and local taxes are destined to rise sharply because of the huge deficit in public worker pension and health care plans, if nothing else.

Taxes can be $500 per month this house, in many areas.

Add insurance at $100 per month and you are at $600 per month...but that isn't all.

Almost impossible today when you retire to even downsize your home, paying off the mortgage and coming out ahead because of the increased value of the downsized home you purchase. Those who have lived in a home for 20-years are paying less property tax on the larger house they're in than the smaller house they'd move into. I just hope I can still get up the stairs when I'm 75.

[grapejelly]

Re: the myth of the paid-for house

In practice I have found this to be on average $80 to $120 per month. In the NE U.S. for each of about 300 SFHs.

Here is what we've spent on a house annually:

Yard maintenance $1000
Kitchen redone ($30K/15 year life) $2000
Bathroom redone (2 @ $15K/15 year life) $2000
painting ($6000 / 5 year life) $1200
carpets/floor $600
tree removal and trimming $1000 (at least)
major repairs $1000 - $2000 (major plumbing, HVAC, water heater, roof, basement leaks, I could go on and on)

caulking, tile repair, broken doors, hinges, cupboards $400

More like $10,000 per year

As I analyze it, whereever I've lived, the Total Costs of Ownership aside from interest expense and amortization of a typical house can be 3/4 or more of the costs of renting the same dwelling.

There are some areas (parts of Indiana for instance) that have very low housing prices in general. But again, they have high property taxes and the costs that I have indicated above still apply. So even where houses are cheap to buy it doesn't really matter -- renting today is cheaper than owning.

A house is a big liability and people have forgotten this. I think the people who have purchased these McMansions will be extremely conscious of this.

I know of at least one elderly neighbor who couldn't afford her house anymore even though it was paid for.

[Finster]

Re: the myth of the paid-for house

Let's assume you pay down your mortgage and own your home free and clear. For many people this is a key part of their retirement plan because they figure their monthly expenses will be much lower without the mortgage and this will allow them to live on a far lower income than otherwise.

Ahh, but it doesn't work that way.

Let's take a house of, say, $224K value.

State and local taxes are destined to rise sharply because of the huge deficit in public worker pension and health care plans, if nothing else.

Taxes can be $500 per month this house, in many areas.

Add insurance at $100 per month and you are at $600 per month...but that isn't all.

You have repairs that are conservatively another $500 per month for the average house. This is low. It may be more like $800 - $1000 per month.

You have to periodically update a house meaning spend $12K on a new bathroom (very cheap) and $30K on a new kitchen. There is yard work, new roof periodically, paint, carpet and flooring, window treatments, caulking and repair of plumbing, and much more as you know.

If you do the work yourself, your time has value doesn't it? When all is said and done, the hidden costs of owning a paid-for house match the cost of renting. And meanwhile you have all your capital tied up. In fact, the hidden costs of a paid-for house can exceed the costs of renting. The big advantage the owners have is in tax savings, but if your income is low anyway this isn't going to mean as much to you.

I lived in California during the Prop 13 war. What is coming up now is more of a general revolt against state and local taxes by the middle class whose standard of living is declining. They find that even a paid-for house is no bargain.

This is misleading, because it assumes you escape those costs if you rent rather than own. In your dreams. Your landlord will embed those costs in your rent or he will go broke.

Sorry, no free lunch here, either. Not only will the landlord ultimately recoup those costs, but he will still ultimately make a profit. If you don't move frequently and can afford the full cost of a home out of pocket, you are better off buying. By far.

Make no mistake. Rents may be low today, but they have never and will never permanently decouple from prices. In the coming years, they will soar just as house prices did the last few. The person who rents in preference to owning today for purely speculative financial reasons is likely to find the tables turned and that he winds up further behind for it.

[grapejelly]

Re: the myth of the paid-for house

This is misleading, because it assumes you escape those costs if you rent rather than own. In your dreams. Your landlord will embed those costs in your rent or he will go broke.

Sorry, no free lunch here, either. Not only will the landlord ultimately recoup those costs, but he will still ultimately make a profit. If you don't move frequently and can afford the full cost of a home out of pocket, you are better off buying. By far.

Make no mistake. Rents may be low today, but they have never and will never permanently decouple from prices. In the coming years, they will soar just as house prices did the last few. The person who rents in preference to owning today for purely speculative financial reasons is likely to find the tables turned and that he winds up further behind for it.

I agree that it will at some point be better to own than rent. But that isn't true now. It hasn't been true for several years. I expect that owning will become attractive again in the next few years.

[Harry Pottery]

Re: the myth of the paid-for house

The "paid for house" is something that I always get a kick out of. First of all, the idea that people who are paying a mortgage "own their own home"--that's a laugh--but an altogether different topic.

As for the "paid for house", yes it's always subject to taxes. And then there is the insurance (although sometimes you can forego this at your own risk, if you really hold the title). But don't forget zoning! You never really own that house or the land, because you can never do with it what you please. A prime example right now is NAIS--homesteaders will know what I'm talking about. This is the law that, if it passes, requires that you register every livestock animal on your property. No more producing your own food--chickens, cows etc.--without complete and total government oversight. There is no such thing as owned land anymore. Even the color of your garbage cans can be controlled by state intervention.

And considering that the odds of actually paying 30 straight years of mortgage payments without a hitch is laughable, there really is no way to ever achieve home ownership for most people. Nobody today--in the age of 5-7 career changes-- is ever sedentary enough (or has a consistent stream of income) to make these payments.

More and more, I think this whole house of cards is going to come tumbling down sometime relatively soon. Economic reality has been ignored for so long that our "leaders" have themselves brainwashed. Like the Soviet Union--not to mention Rome--eventually the numbers are going to stop adding up.

[grapejelly]

Re: the myth of the paid-for house

I forget who pointed this out...perhaps Schiller. But if you look over a long, long period of time, real estate just about keeps up with inflation.

What people don't recognize is what a huge liability owning your own home is, given that if you aren't selling the house because you intend to live there, inflation works against you -- taxes only go up, costs of maintenance only go up, insurance only goes up.

Inflation is only your friend if you borrow money to own an asset. If you don't borrow the money, because your house is paid for, you are the victim of inflation.

[Sapiens]

Re: the myth of the paid-for house

I forget who pointed this out...perhaps Schiller. But if you look over a long, long period of time, real estate just about keeps up with inflation.

What people don't recognize is what a huge liability owning your own home is, given that if you aren't selling the house because you intend to live there, inflation works against you -- taxes only go up, costs of maintenance only go up, insurance only goes up.

Inflation is only your friend if you borrow money to own an asset. If you don't borrow the money, because your house is paid for, you are the victim of inflation.

GJ,

You need to make a distinction between an asset and a security.

If you are living in your house without a mortgage, you are enjoying the utility of a security and must pay its inherent carrying cost.

While let’s say your house is also a self sufficient farm that pays for itself without your effort, then it is an asset.

[Finster]

Re: the myth of the paid-for house

I agree that it will at some point be better to own than rent. But that isn't true now. It hasn't been true for several years. I expect that owning will become attractive again in the next few years.

I conceded in another thread that it was wrong of me to imply that your personal decision to rent in favor of owning may not be right for you. Clearly one-size-fits-all tactics do not apply to different individuals with different financial circumstances, abilities, goals, who live in different regions and localities. That last part is especially significant, because unlike stocks and bonds, real estate markets are local.

But that is just what you are doing now, by implying that because a particular strategy may have been right for you, that everyone should now follow suit, sell their home, and move into a rental. I will not let such a gross over-generalization pass unchallenged.

There is no "myth" of the "paid-for house". I live in such a dwelling and know from personal experience that it is not a myth.

I was among those who argued a couple of years ago that people buying a home with no money down on an option-arm, no-doc loan were engaging in serious folly. Not only that, but that anyone buying a home with less than 20% down on other than a traditional fixed-rate mortgage was courting trouble - if he was doing so because house prices "were going up".

But many people did choose to speculate with their own homes. They actually bought when their personal circumstances augured in favor of renting. Priced had been rising. And they were just as certain as that home prices were going to continue to rise as you are now that they will continue to fall. The mere fact of taking the other side of the trade does not change the fundamental error of speculating with one’s own home on the basis of projecting the recent past into the future.

There are good and sufficient reasons to choose between owning and renting. They include how often one moves - specifically how long on intends to remain in the particular home - and, if one cannot afford the full purchase price of a home outright - the relative costs of renting the home versus renting the money with which to buy it.

Since you presume to give generalized guidance that applies to everyone, I can refute it with a single example. In 2005, I sold a fully-paid-for house and bought another fully-paid-for house. Yet, rather than being personally harmed in any way, I have been watching the housing market and mortgage debacles with detached bemusement, as if floating over in a balloon. It simply has no bearing on me. Why? I bought the house to live in, not for a speculation. I don’t plan to sell it later on and apply my "profits" towards something else that is not a home.

And to underscore the folly of assuming that what applies in one part of the country applies to everyone, it turns out that the part of the country I live in never saw a bubble in the first place. The local economy happened to be fairly manufacturing oriented during the bubble that was manifest elsewhere. In 2005, when the mania was at its peak, I purchased a beautiful, six-bedroom home, in a lovely, quiet, small town with excellent schools for a scant 40% of replacement value by insurance company estimates. If this were an investment, it would be classic Graham-and-Dodd deep-value investing. In contrast, the home I sold at the same time was in one of the hot bubble markets and had skyrocketed in recent years.

I should be talking about the "myth" of the "myth of the paid-for house".

Yet there is more to it than that. I will even go so far as to suggest that the person considering his next residence - assuming he falls in the category of someone not planning to move soon, having a 20% down payment for a 30-year-fixed, and choosing between renting the property or the money with which to buy it - would be doing the smart thing by buying the home.

The caveat of real-estate locality and personal circumstances of course still applies. But it is not just my contrarian sensibilities that argues in favor of this conclusion. We are set up for a period of inflation and dollar devaluation. Interest rates are, right now and in the near future, probably near the low point of the next twenty years. The buyer of the home will own a real asset, while the dollars he will be expected to repay will be depreciating. The renter, on the other hand, is actually going short a real asset while paying for the privilege of doing so.

The purchase-deferring, would-be homeowner in this circumstance is likely to find that even if his dream house becomes available at a lower price, the increased interest rates will more than offset the difference and the reward for his speculation will be learning he is not as clever as he thought.

Meanwhile, our renter-speculator is stepping into a "bubble" of escalating rent. The choice he will face down the road will not include the option of buying his dream home on the cheap, but between acceding to stultifying rent increases or stultifying mortgage payments. He will regret using his home as a financial speculation just as those who did so a couple years ago do now.

[SeanO]

Re: the myth of the paid-for house

Almost impossible today when you retire to even downsize your home, paying off the mortgage and coming out ahead because of the increased value of the downsized home you purchase. Those who have lived in a home for 20-years are paying less property tax on the larger house they're in than the smaller house they'd move into. I just hope I can still get up the stairs when I'm 75.

In CA there is an interesting law that allows seniors (over 65) to move and keep their original tax basis. There are some limitations, for example you can't change counties unless the counties have a reciprocity agreement. Still it does make downsizing without property tax consequences quite possible for CA's retirees.

SeanO

[grapejelly]

Re: the myth of the paid-for house

Finster, you could be right that buying a house now (or in the near future) is the "right" move for many people. And as you say, it is in any event an individual decision.

My point in using this hyperbolic subject line is to show that even if people do eventually pay off their house, they still may find that the costs of ownership are so onerous that they cannot afford to live there and certainly not with the lifestyle they may have anticipated.

I contend that major increases in state and local taxes are in the works, in order to pay for defined benefit pensions and health benefits of the local government workers who are starting to retire.

These taxes will be additional burdens on the backs of homeowners. Inflation works against homeowners because the costs of ownership continue to rise, to the extent that people around where I live face $1000 per month or higher costs of living in their "paid for" house. (Property taxes are easily $500/month, insurance $100/month etc.)

So this actually runs counter to your contrarian idea that buying a house might be "best" right now (again, tossing aside personal situations and just speaking necessarily in generalities for the sake of this discussion.) There will be more and more people with more house than they need, who can't afford their homes' taxes and costs, and find that they want to downsize or rent.

And I think this may drive the real value of homes down for many years.

In some cases, just heating and cooling these houses costs $300 or more per month. As people retire in their "paid for" houses, they are going to find that they can't afford the costs of a "paid for" house anymore

[SeanO]

Re: the myth of the paid-for house

grapejelly - while I don't particularly disagree that now may not be a bad time to rent depending on personal circumstances, there are a couple of flaws in your logic. Particularly that the following two items don't apply to renters as well as owners:

These taxes will be additional burdens on the backs of homeowners. Inflation works against homeowners because the costs of ownership continue to rise, to the extent that people around where I live face $1000 per month or higher costs of living in their "paid for" house. (Property taxes are easily $500/month, insurance $100/month etc.)

Your assumption that rents will not increase to account for these costs is absurd. Keep in mind that ALL rental property is an investment, on which the owner expects a certain return. The return is commonly referred to in the real estate industry as the cap rate... the return on capital. Commercial properties have recently seen cap rates fall into the 5-6% range... a range which has prompted much debate regarding the risk/reward of owning commercial property at the moment.

Housing is far worse in many areas. Locally I can rent a $600k house for $2k per month. That puts the cap rate at 3%, and that assumes I pass on all expenses except property taxes to the renter!!!

Many landlords were willing to accept these ridiculously low cap rates because they planned to make up the difference on appreciation. It should be clear to everyone now that is not going to happen in the near term. Without the promise of appreciation I GUARANTEE that cap rates on residential rentals will return to AT LEAST the 5-7% range --- though it may take some time (still a bit too much housing inventory at the moment which is holding back landlords pricing power).

Now that can only happen a couple of ways. Rents can double or prices can drop by 50%. If you think prices are going to drop by 50% then get out of the pool and rent for sure. If you think we are likely to have poom like inflation then the next couple of years (ka?) might not be a bad time to find a place to own and lock in an interest rate while they are still low. Just be sure that if you buy, you can afford it... reasonable payments, 20% down, etc.

In some cases, just heating and cooling these houses costs $300 or more per month. As people retire in their "paid for" houses, they are going to find that they can't afford the costs of a "paid for" house anymore

I haven't seen many offers for free heating and cooling with rentals... while like food this is a cost we have to bear, it has nothing to do with ownership.

[Finster]

Re: the myth of the paid-for house

Finster, you could be right that buying a house now (or in the near future) is the "right" move for many people. And as you say, it is in any event an individual decision.

My point in using this hyperbolic subject line is to show that even if people do eventually pay off their house, they still may find that the costs of ownership are so onerous that they cannot afford to live there and certainly not with the lifestyle they may have anticipated.

I contend that major increases in state and local taxes are in the works, in order to pay for defined benefit pensions and health benefits of the local government workers who are starting to retire.

These taxes will be additional burdens on the backs of homeowners. Inflation works against homeowners because the costs of ownership continue to rise, to the extent that people around where I live face $1000 per month or higher costs of living in their "paid for" house. (Property taxes are easily $500/month, insurance $100/month etc.)

So this actually runs counter to your contrarian idea that buying a house might be "best" right now (again, tossing aside personal situations and just speaking necessarily in generalities for the sake of this discussion.) There will be more and more people with more house than they need, who can't afford their homes' taxes and costs, and find that they want to downsize or rent.

And I think this may drive the real value of homes down for many years.

In some cases, just heating and cooling these houses costs $300 or more per month. As people retire in their "paid for" houses, they are going to find that they can't afford the costs of a "paid for" house anymore

But that overlooks the fact that those costs must and will be passed along to renters as well. If it costs more to keep up a property than a landlord can obtain for renting it out, the property will come off the market, shrinking the supply. For the remaining properties, rent will rise to cover taxes and maintenance. Utilites will be billed separately or will also contribute to rent. So at best any net "profit" opportunity will be transient - not a favorable circumstance for someone dealing in an illiquid market like real estate.

I agree, however, as to your larger point - and that is that living costs are going to rise. This is perfectly copasetic with my point about inflation becoming an increasingly visible problem. This has to do with the insidious nature of inflation - early in the cycle, the price effects are most visible in the most liquid assets - things like stocks and bonds - and while that is happening, it's a very popular phenomenon, so there is little objection to it. But as the cycle progresses, it filters into less liquid assets (like homes) and ultimately into the prices of commodities and wages. This will drive up the cost of living no matter where you live. It is simply not going to be fun anymore for the average person and most will find their real standard of living facing a strong headwind.

Inflation didn't just happen yesterday, though, it's been there all along, even while its price effects have morphed from one area to another. Looked at this way, the "real" value of the average house simply never rose the way nominal prices would suggest in the first place. What we just experienced was primarily a massive devaluation of our dollars in comparison to our houses. That it was nearly coextensive with a similar devaluation of those dollars against oil, gas, copper, gold and other real, tangible, assets lends strong support to this view. And if that is the case, the assumption that houses will undergo a steep decline in "real value" based on a presumed steep rise in the same is suspect.

What we need to be looking for next is one of two things. The first alternative is that the phenomenon outlined above will go into reverse, and we will experience an upvaluation of our dollars against houses, gold, copper, oil, gas, etceteras. In other words, deflation. The other is that the price effects of inflation will move into areas which have yet to feel them as strongly as has been reflected in those things; including - likely - rent.

Based on your record of commentary here, I surmise that you are not a deflationist, but rather expect an escalating cost-of-living spiral for some time. Here again, we agree. For the moment, we are experiencing a whiff of deflation as the Fed has been attempting to defend its implicit "inflation target" with a bit more restrictive monetary policy. But evidence of stresses as a result are beginning to accumulate; not least in the housing market. It is only a matter of time before the Fed turns the main focus of its efforts to fighting not inflation, but economic weakness. When that happens, we will want to already be safely ensconced in real assets. That clearly includes those of monetary value such as precious metals, and perhaps less obviously, commodities like energy and even homes.

Again, I am not advocating that people for whom renting makes practical sense run out and lever up on a house, but likewise there is no reason why anyone who owns a house for similarly practical reasons to do the opposite and rush it to market so he can sidestep presumed further declines in house prices. The mistake made by so many was in buying more house (or more houses) than they needed or could afford, on the premise of presumed further increases in house prices. Those who treated their residence as a consumption item and bought only what they could afford and needed and enjoyed are an entirely different group.

And again, I agree that taxes and other costs are going to rise and that standards of living are going to take a hit as a result. I simply don't believe that for the vast majority, choosing to rent rather than own is going to provide a shelter from the storm for any more than the briefest of periods.

[grapejelly]

Re: the myth of the paid-for house

Great points, thank you! The argument that landlords will pass along all these costs makes perfect sense.

But, also as you point out, there is a supply-and-demand aspect to being a landlord and rental units compete with other rentals as well as the attractiveness of owning!

This could go on for years making it more expensive for many to own a paid-for house than to rent.

When I rented an apartment in Los Angeles 25 years ago, it cost $600 for a one bedroom in a good area. The same apartment today probably costs $1600. But a house that cost $200,000 then costs $1.2 million today in the same area.

If I lived there again, I would rent and not buy. There is too much downside to owning compared to renting.

For renting vs. buying to even out, real house prices have to decline very significantly in the areas where they have appreciated the most. And probably rentals must rise.

Therefore I think that SFR values are falling in real terms for awhile in some areas. Perhaps 2 or 3 more years in some areas, 10 or 15 years in others.

(As you say, housing is a collection of local markets so generalities can be dangerous but in general I think this is what we are in for.)

Even if nominal prices only decline 10% - 15% per year in many areas for a number of years, it will still be expensive to have a "paid for" house and renting may be more cheaper for quite awhile.

The housing decline makes it difficult for many to sell and instead of selling, they rent their houses out. Condos are rented out and compete with apartments. Houses are rented out and compete with houses for sale.

You're right that an apartment dweller also has to heat or cool her apartment. But many of the newer homes that have been built are too large and expensive to heat and cool compared to rental units. And the boomers are at an age where they no longer need to house their children so their existing house is really more than they need.

The same arguments that stagnant real wage levels make it difficult for recent home buyers to afford their mortgage payments assure a big supply of homes that will be for sale or for rent in the next few years.

And the competition for the renters perhaps dooms landlords to a period of below-average returns.

To illustrate, I have an elderly relative who sold her house and has rented another house in recent years. She could not afford her house anymore due to the taxes, insurance, maintenance, and everything else.

And she wanted to employ her equity. Some opt for a reverse mortgage but she opted to sell her house.

She banked the proceeds and has been living on interest and dividends. She rented a house comparable to the one she once owned.

The landlord is enduring an extremely low cap rate because of the supply-and-demand situation and it will be years before this alters to its historical norm in her area.

If I lived in her area, it would be very hard for me to afford a mortage, but I could afford to rent. Even if I did buy, I would own a declining asset. If I put 20% down, a 10% decline in value per year is a 50% cash-on-cash loss. Wowzers!

How many years will it take for this to correct itself? And how will quickly rising property taxes affect the process of renting/owning normalization?