the myth of the paid-for house

[Finster]

Re: the myth of the paid-for house

As suggested earlier, we need to beware of making broad generalizations in real estate markets. Undoubtedly there are some areas where, perhaps due to rent controls, extremely high ownership prices, or other market inefficiencies, where renting would make sense purely from an economic perspective, particularly where the resident doesn't have a choice of owning outright, but must choose between renting the property or the money to buy it.

As for the over-sized home argument, if we are comparing owning versus renting, we have to control for size. Comparing the cost of owning a huge McMansion with the cost of renting an efficiency apartment is not an apples-to-apples proposition. One often has the choice of owning a small home versus renting a small home, or owning a large home versus renting a large home; and that is what needs to be compared if the question at bar is owning versus renting.

And as alluded to with the inflation point, outright nominal house price declines can be expected to be reversed if sufficient inflation takes place. Naturally, you don't expect this if you expect a long-term, Japanese-style deflationary scenario, but I am more concerned about rampant inflation as the Fed tries to paper over the catastrophe engendered by its previous policy mistakes.

And don't forget, we have that deflation fighting ace in the pilot's seat of yonder helicopter ...

[jk]

Re: the myth of the paid-for house



from sharelynx

i'm not sure what, if any, part of this graph you want to call normal or baseline, but i thought it relevent to the discussion here.

[bobola]

Re: the myth of the paid-for house

Grapejelly,

Thanks for reminding me of the financial reasons I want to live on a sailboat.

1) no property tax.

2) no neighborhood association fees.

3) no yard maintenence (unless we are talking about the boat yard)

4) no special assesments (the street and sidewalks on our block were rebuild a few years ago and we are paying a share of that)

One downside is insurance costs, but if a prudent skipper avoids bad storms and has a good set of storm anchor gear, and can ensure the boat won't sink when nobody's onboard, liability insurance should be all that's needed.

The other downside is the cost of marine gear (sails and standing rigging, for example) but as a handyman I can fix most of it so labor costs are a minimum.

The other advantage to living full time on a sailboat is the ability to quickly move if the grass looks greener elsewhere, with minimal cost.

I predict massive civil disorder here in the USA within 5 years based on the direction Washington and bankers are leading us.

[blazespinnaker]

Re: the myth of the paid-for house

Yeah, but you can do a lot of that work yourself and cut down about 90% of it.

Life will get expensive if you get the 'help' to do all the work, of course.

But the, if you can afford that, then you shouldn't be complaining!

[SeanO]

Re: the myth of the paid-for house

Right Blaze! Not only that but you aren't going to get $15k bathrooms in most rentals. Many of the maintenance items often aren't included either, or are at least more basic in nature.

While at the moment rents in a number of areas are comparatively cheap as evidenced by cap rates it does not negate the entire concept of ownership. Nor is it true everywhere. Opposite was true 2 years ago when everyone was saying that renting made no sense. What really changed other than perception???

Higher costs for buying amenities you don't need, buying more house than you can afford, and paying people to do all the maintenance for you, etc. are ALL spurious arguments against home ownership.

The successful landlords I know often do their own work, they buy only what they can afford, and they don't improve things unnecessarily.

Why folks throw all financial reason out the window when it comes to their own home is beyond me.

[BlackVoid]

Re: the myth of the paid-for house

Repairs??? Maybe $50/mo.
Do the work yourself. Repainting and redoing the bathroom/kitchen are not neccessities. Repainting is also CHEAP if you do it yourself.

[Finster]

Re: the myth of the paid-for house

Right Blaze! Not only that but you aren't going to get $15k bathrooms in most rentals. Many of the maintenance items often aren't included either, or are at least more basic in nature.

While at the moment rents in a number of areas are comparatively cheap as evidenced by cap rates it does not negate the entire concept of ownership. Nor is it true everywhere. Opposite was true 2 years ago when everyone was saying that renting made no sense. What really changed other than perception???

Higher costs for buying amenities you don't need, buying more house than you can afford, and paying people to do all the maintenance for you, etc. are ALL spurious arguments against home ownership.

The successful landlords I know often do their own work, they buy only what they can afford, and they don't improve things unnecessarily.

Why folks throw all financial reason out the window when it comes to their own home is beyond me.

Right Blaze and Sean! ;) Glad you mentioned cap rates, because it is not widely appreciated that they have a tendency to track interest rates (market arbitrage). So when interest rates fall, rents in relation to prices fall as well. Of course, this can mean prices rise in relation to rents, and did mean just that over the past few years.

What do you think will happen to interest rates in the coming years? Once you've answered that question, you have an idea what you expect from cap rates. So if you think rising interest rates are in our future, you ought also to expect prices to decline in relation to rents. But it is crucial to keep in mind that cap rates can rise just as easily by rents rising as by prices falling. And unless you expect pervasive deflation, even more easily.

Most folks should not be basing their decision to own or rent on a view of the real estate markets; one's own personal circumstances are usually more predicable than markets. Renting versus owning ought to be a function of what one wants versus what one can afford and how often one expects to move. The pendulum can swing unexpectedly and the speculator who thinks he is being clever by renting instead of owning at this time is likely to turn out to be no smarter than the one who thought he was being clever by owning instead of renting a couple of years ago. He may soon find his rent escalating even faster than home prices did. The truly smart one will make the decision on personal practical considerations.

Aside from non-financial issues such as frequency of moving, probably the main one is net worth. If you have little, your choice is between renting a home or the money with which to buy one. If you have a sizable net worth, you have to do something with it anyway. Aside from joining the brotherhood and taking a vow of poverty, there is no such thing as having one's assets in nothing. Really fond of stocks? Bonds? Gold bug? Whatever, do you really want to have your whole nest egg in one asset? If you have sufficient assets to own the mythological paid-off house and some left over, you may as well include at least one asset that you can use and enjoy.

[grapejelly]

Re: the myth of the paid-for house

Renting versus owning ought to be a function of what one wants versus what one can afford and how often one expects to move. The pendulum can swing unexpectedly and the speculator who thinks he is being clever by renting instead of owning at this time is likely to turn out to be no smarter than the one who thought he was being clever by owning instead of renting a couple of years ago. He may soon find his rent escalating even faster than home prices did. The truly smart one will make the decision on personal practical considerations.

When and if I had many millions of dollars I would opt for a paid-for house but if that isn't my circumstance, my decision to own or rent is a huge determinant of my current and future net worth.

If you have a long enough time horizon, just as in the stock market, ultimately you will come out okay.

But real estate purchases are highly leveraged. So if I own, and I end up having to sell and move in, say, 3 - 5 years, I could face a huge loss in net worth due to the leverage working against me.

I faced this already in California. I was "trapped" in a home that was worth less than the mortgage. And I wanted to move out of that house. It wasn't fun.

I think it is vital for many people who aren't sure how long they are going to live somewhere, to make the right decision rent vs. buy. Let's forget personal factors for a moment. Assume the financial implications outweigh personal ones.

In our present circumstance, renting has been far cheaper than owning. That has been true for many years. I believe that real house prices will fall, and real rents will rise. But nevertheless, it will still be much more advantageous renting for the foreseeable future.

In the long run, rents and housing prices should reach an equilibrium but that is in the long run, many many years. Meanwhile:

1. Rents are constrained by immediate supply and demand situations -- competition from apartments as well as houses offered for rent.

2. Rent rises are constrained by real wages to a greater extent than housing price rises, which are constrained by the availability of cheap and easy credit.

Housing prices are set to fall in real terms. 10% per year over three years, if your house cost $500K, is a approximately a $130K haircut. Even if rents go up quickly, they may be $2000 per month the first year, then $2400 the second year and $2800 the third year, as an example, than owning that house and taking the capital loss. (But of course you can sign a lengthy lease and protect yourself as a renter during the term of the lease.)

Rents and housing prices usually don't move suddenly up or down. They trend over long periods of time. You can get a 3 year lease and then see how things go, and you are not risking a huge capital loss. Even if rents rise smartly (unlikely unless wages rise smartly), you will still lose very little by opting to rent.

The exception of course is in times of strong housing appreciation. That period, which is past us at least for now, is what led to the huge disparity in the costs of renting versus owning anyway. And it will take a number of years to reach equilibrium, during which time it may well pay handsomely to rent.

[SeanO]

Re: the myth of the paid-for house

I think it is vital for many people who aren't sure how long they are going to live somewhere, to make the right decision rent vs. buy. Let's forget personal factors for a moment. Assume the financial implications outweigh personal ones.

To our point, not being sure how long you are going to live somewhere IS a personal factor. In and of itself it negates your argument that this is solely a financial matter.

In our present circumstance, renting has been far cheaper than owning. That has been true for many years.

That's ridiculous. The house I bought for $215k 9 years ago peaked at $850k and is still worth $750k. Even if it fell 50% to $425k buying that house would have been a far better decision than renting. Rents have increased 50% during that time for that house $1200 to $1800. Not so with a fixed 30 year mortgage. Plus no benefits of appreciation to the renter.

Now I'm not suggesting similar appreciation is likely over the next 10 years. But 10 years is a long time and I don't think any of us can truly predict what will happen to home prices, interest rates, and rents. So again, your one size fits all, no one should buy a house argument just doesn't make sense to me. Again it comes down to personal circumstances. If you find a house you like, have a down payment, can afford the carrying cost, and lock your mortgage for 30 years, is certainly removes a lot of uncertainty in one's life.... which alone has VALUE.

Housing prices are set to fall in real terms. 10% per year over three years, if your house cost $500K, is a approximately a $130K haircut.

That is entirely too general a prediction. Real estate markets are still fairly local in nature. Using CA as an example the impact in San Francisco will be different than Fresno. And some areas have already seen a 10-20% haicut... so if your predicting 30% we are already getting close in a few spots.

Even if rents go up quickly, they may be $2000 per month the first year, then $2400 the second year and $2800 the third year, as an example, than owning that house and taking the capital loss. (But of course you can sign a lengthy lease and protect yourself as a renter during the term of the lease.)

What if you can only afford $2000 in this scenario... then you've had to move once a year, vs. having a 30 year fixed mortgage and being able to sit tight. Personally avoiding the combined loss of productivity and hard costs of moving are worth a lot to me.

So again it depends on your personal circumstance and what you value. Locking in a lease may help but it has its own risks, and I'm not sure you'll find many landlords signing lengthy leases in a potentially inflationary environment.

Rents and housing prices usually don't move suddenly up or down. They trend over long periods of time. You can get a 3 year lease and then see how things go, and you are not risking a huge capital loss. Even if rents rise smartly (unlikely unless wages rise smartly), you will still lose very little by opting to rent.

While I wouldn't recommend everyone run out and sign a 3 year lease, I see little reason for most people to rush into a purchase at the moment. On that I'm sure we agree.

[grapejelly]

Re: the myth of the paid-for house

That's ridiculous. The house I bought for $215k 9 years ago peaked at $850k and is still worth $750k. Even if it fell 50% to $425k buying that house would have been a far better decision than renting. Rents have increased 50% during that time for that house $1200 to $1800. Not so with a fixed 30 year mortgage. Plus no benefits of appreciation to the renter.

Now I'm not suggesting similar appreciation is likely over the next 10 years. But 10 years is a long time and I don't think any of us can truly predict what will happen to home prices, interest rates, and rents. So again, your one size fits all, no one should buy a house argument just doesn't make sense to me. Again it comes down to personal circumstances. If you find a house you like, have a down payment, can afford the carrying cost, and lock your mortgage for 30 years, is certainly removes a lot of uncertainty in one's life.... which alone has VALUE.

I did say that "if you have to move in 3 - 5 years..."...it depends upon your time horizon.

People think about impermanence and instability in terms of renting...but the same holds true of owning if you have to sell your home and move. Some people "know" they won't have to do that, but how can they really know? And many people "know" that it is entirely possible they will have to move in 3 -5 years. This enters into the equation.

I said forget personal factors because of course they can override financial ones, but I wanted to address financial circumstances on this website rather than personal ones.

Your example of an appreciating house sort of makes my point. It paid to own because you participated in The Great Asset Inflation. It is cheaper to rent the same house *now* than it is to buy yours. You aren't in that situation because you bought at an earlier and cheaper time.

But you have to continually reassess this. Let's assume you have, say, $400K in equity. Is that something you care to jeopardize? Is it something that you are okay with having largely disappear? That could happen if home prices fall and you have to sell and move, unexpectedly.

[SeanO]

Re: the myth of the paid-for house

But you have to continually reassess this. Let's assume you have, say, $400K in equity. Is that something you care to jeopardize? Is it something that you are okay with having largely disappear? That could happen if home prices fall and you have to sell and move, unexpectedly.

I didn't buy that house to speculate, I bought it to LIVE in. And because I don't believe in frivolously spending my home equity, how much equity there is, or isn't, is absolutely meaningless until I decide to sell. (BTW. I did actually sell that house back when it was in the 300's)

Two years ago my friends parents felt the peak of real estate had been reached in Palo Alto, CA. A very reasonable position then as now. They sold and pocketed huge gains. But now they hate where they live and desperately want to return to Palo Alto. They can't. Worse than the additional 15% appreciation, is the fact that their property taxes would be exponentially higher which they simply can't afford. I should also mention that years ago they bought at a peak, and were underwater for years. But their kids went to top schools, they loved the area, and never regretted it.

I am certainly not saying that your decision to rent is wrong. I'm just saying that you can't apply what is right for you to everyone else.

[jk]

Re: the myth of the paid-for house

i don't know if either of you [gj or seano] read john hussman, but he occasionally writes about how you can predict long term returns in the stock market [but not short term] by looking at valuation. i think the same is true in every market. in general, i think you'd both agree that we are much closer to a peak in housing prices than a trough. that said, it implies that, viewed as an investment, now is not a good time to buy if your interest is a high probability of a good long term financial return.

[grapejelly]

Re: the myth of the paid-for house

i don't know if either of you [gj or seano] read john hussman, but he occasionally writes about how you can predict long term returns in the stock market [but not short term] by looking at valuation. i think the same is true in every market. in general, i think you'd both agree that we are much closer to a peak in housing prices than a trough. that said, it implies that, viewed as an investment, now is not a good time to buy if your interest is a high probability of a good long term financial return.

Hussman and others point to dividend yields as a key indicator on stocks' valuation. Similarly, houses have yield in the form or rents as a measure. Cap rates. If I rent a $600K house for $24K per year, and my taxes are $6K and insurance and expenses etc. are another $5K that's $11K, for a cap rate of what, under 2%?

Seems to me, should be more like 8% or 10%...

[SeanO]

Re: the myth of the paid-for house

i don't know if either of you [gj or seano] read john hussman, but he occasionally writes about how you can predict long term returns in the stock market [but not short term] by looking at valuation. i think the same is true in every market. in general, i think you'd both agree that we are much closer to a peak in housing prices than a trough. that said, it implies that, viewed as an investment, now is not a good time to buy if your interest is a high probability of a good long term financial return.

Don't get me wrong I am not saying that in general this is a great time to buy. I am saying the "myth of the paid-for house" is ridiculous... even right now.

The cap rate analysis which I introduced earlier in this thread is absolutely a good decision tool when analyzing a particular market. But apply the analysis locally; and also consider where you believe interest rates, rents and home prices are headed; and then consider your personal situation (likelihood of a move, value of stability, etc).

You can't simply throw all sense aside just because we believe we are at a peak... no more than you should when we believe are in a trough.

I was just doing my monthly analysis on CA foreclosures. Sacramento has 1 foreclosure for every 2,600 people, whereas San Francisco has 1 for every 50,000 people. These two markets are as different as night and day and they are only ONE hour apart. Eric's geographic regions cascade theory helps explain this. But still there are significant differences within Sacramento, let alone across the country.

While this real estate bubble has NATIONAL financial implications for lenders and the economy, the timing and degree of impact on individuals will vary widely on a LOCAL basis. One size will not fit all.

[Finster]

Re: the myth of the paid-for house

But real estate purchases are highly leveraged.

This is a false statement. Many real estate purchases are highly leveraged. Not real estate purchases in general. And since the topic here is "… the paid-for house …", it is those that are not highly leveraged that we are particularly concerned with here.

So if I own, and I end up having to sell and move in, say, 3 - 5 years, I could face a huge loss in net worth due to the leverage working against me.

Let’s stay on topic. Assume you buy a house today (sans leverage). Let’s also assume you are being sensible and rationally looking at it as a consumption item, not a financial speculation. This means you buy as much house as you want for the purpose of living in, and not buying "extra" house on the anticipation of selling that extra portion later on and using the proceeds for something that is not for the purpose of living in.

Say you buy a $500,000 home. And further assuming your bearish outlook turns out to be correct, in five years, housing prices have declined by 20%. You now move, selling the home for $400,000. Should you fret about that ostensible $100,000 "loss"? No. For you are now buying another house for $400,000 that once sold for $500,000 and is equal in "real" value to the one you bought today. Put $100,000 in the plus column for that side of the transaction. You have lost nothing.

Remember, you bought that $500,000 house today just because it was worth $500,000 to you (not on speculation as to what prices may do in the future). You paid $500,000 for something of at least that value to you, and 3-5 years later, you still have something of at least that value to you. Again, you have lost nothing.

What can we conclude from all this? It's simple. All of the downside risk from owning versus renting comes from only two factors: 1) Leverage (going long house while going short dollars), and 2) Buying more home than your utilitarian objectives warrant on the speculation you will take profits on the excess and use them for something else.

Let's forget personal factors for a moment. Assume the financial implications outweigh personal ones.

We can’t just make that assumption in a cavalier manner. In fact it is a core bone of contention in this debate.

In our present circumstance, renting has been far cheaper than owning.

Another false statement. In some areas, renting has been far cheaper than owning. Moreover, the question before us is not what has been cheaper, but what will be cheaper. The wisdom of a decision made today will hinge not on the former, but the latter.

Housing prices are set to fall in real terms.

Again, you are making an invalid extrapolation from the specific to the general. What may or may not happen in a hot California market can not tell us about "housing prices" everywhere.

Houses are not like stocks. If you buy a stock in California, you pay the same price as someone buying it in New Jersey. It can move from one coast to the other in the twinkling of an eye. Real estate just can’t do that.

Moreover, the phrase "real terms" needs to be examined more closely. One can make an excellent case that average US housing prices have done little in "real terms" in recent years. I think that most of that "appreciation" is an illusion caused by a decline in the value of the dollar, not an increase in the value of the house. Otherwise, we are hard pressed to explain similar action in a number of unrelated items, such as oil, gas, gold, copper.

Are you going by the CPI?

If so, we need to talk.

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