Real Estate: Fundamentals

[Cutten]

Quote from OldTrader:

As a place to live a house has numerous things to offer that a rental does not have. You can decorate as you choose. You can add-on, you can rehab. Etc etc. There is a value to these types of intangibles.

Then there is the idea that when you own a home you can pay it off over time. You can never pay rent off. In fact, I don't personally know of an area in the country where rents have gone down over time. They always go up.

So what you can count on is this: over time, you can own the house you buy. Over time, a rental can never be paid for, and in fact, rent will rise considerably over your life time.

No one sits down with pencil and paper to figure out what it is worth to them to not deal with a landlord, to be able to redorate when and in the manner that they choose. But it has value that no one on Wall Street or on this site ever pays any attention to. There is a gut level desire to own your own home.

But assuming no appreciation at all, over a period of time the buyer will be way ahead of the renter because of loan pay down versus inexorably rising rents.

OldTrader

Everyone with a brain is well aware of the positives of owning your own home, as well as the negatives (maintenance, lower flexibility for relocation e.g. for a new job etc). People are simply saying that these factors have little bearing on *changes* in RE prices. The benefits and negatives of owning RE are priced-in to the market, and are therefore fairly useless for forecasting. The intangibles help explain the *level* of prices, but not the rate of price appreciation (or depreciation).

The pros and cons of owning RE in, say, California, were the same in 1990 as in 1995, 2000, and 2005. Therefore they cannot explain the big price swings from 1990-95, 1995-2005 etc. We must look to other factors to explain the price falls then rises over that time period. Rental cashflows relative to historical norms for an area are a fairly good measure of value. Whereas being able to do your own decoration has nothing whatsoever to do with whether your home is cheap, fairly priced, or overvalued. Home ownership had intangible benefits in Osaka in 1990 - that didn't stop prices of residential RE falling 80% over the next 15 years.

 

[Sparohok]

Quote from Retired:

I guess you don't really read what's being posted.

I stand corrected.

With that said, I think Hydroblunt was commenting on current real estate valuation. There is a subtle distinction here that I overlooked.

Today, it is in fact more expensive to buy than to rent in many areas of the country. That is likely to be true even if you keep the house for 10 or 20 years. That does not mean that renting is always cheaper than buying; there is every reason to believe that p/e ratios on houses will mean revert, at which point buying will again make more sense than renting, as it usually does for a long term resident.

Hydroblunt, I'm curious, do you think renting is always a better choice than buying, or just in today's market?

Martin

 

[mschey]

Quote from Hydroblunt:

I do not think people understand that renting is way cheaper than buying and it really does not matter if you get to own your home in 20-30 years when you pay up the a$$ for it with fees, taxes & insurance.

Hydro, you have no clue what you're talking about here. Run the numbers and see who comes out ahead in 20 years, the homeowner or the renter? Nothing worse than an unqualified opinion!

 

[Sparohok]

One thing that I find curious about this and other real estate threads is all the so called traders advocating buying and holding real estate as an investment. It's ironic given all the derision that buy and hold investors typically get around here.

Personally, the main reason I don't want to buy real estate is because I'm earning far more by trading my capital than I could hope to earn by investing it in a house.

What is it about real estate that turns all these so called elite traders into buy and hold investors?

Martin

 

[mschey]

Real estate acts as forced savings plan. When you pay off principal, you are in fact paying it to yourself. It provides tremendous tax advantages. It protects your wealth against inflation, and essentially allows you to build wealth tax free. 500k tax free is a windfall. These are some of the most powerful reasons for investing in real estate.

 

[Sparohok]

Quote from mschey:

Run the numbers and see who comes out ahead in 20 years, the homeowner or the renter?

I actually did run the numbers on a 30 year fixed mortgage for a property in the SF Bay Area, assuming that both home prices and rents stay constant in terms of 2005 dollars. I accounted for taxes, tax breaks, transaction costs, maintainance, insurance, everything. At 10 and 15 years the renter was ahead, but after 20 years I think buying was a little cheaper. So, it's not necessarily as clear cut as you think, at least not in the most overheated markets.

Martin

 

[OldTrader]

Quote from Sparohok:

One think that I find curious about this and other real estate threads is all the so called traders advocating buying and holding real estate as an investment. That's ironic with all the derision that buy and hold investors typically get around here.

Personally, the main reason I don't want to buy real estate is because I'm earning far more by trading my capital than I could hope to earn by investing it in a house.

What is it about real estate that turns all these so called elite traders into buy and hold investors?

Martin

I've owned rental real estate for most of my adult life...I'll be 60 in June. I've also traded for most of my adult life, from about 20 on with a few years off for the Army.

First let me respond to your comment "I'm earning far more by trading my capital than I could hope to earn by investing it in a house."

I've bought any number of properties where I eventually refinanced all of my cash out of the property. I then held the property with none of my cash in it, and collected rent while the tenants in essence built my equity by paying my loan down.

I've bought a number of properties by assuming existing loans with little to no cash out of my pocket.

So the bottom line here is that when you say that you're earning "far more" with your capital, I'd say that if you were educated in real estate your statement would be incorrect.

Eventually what happens over time is that the properties kick out cash flow without a great deal of effort. I don't work on the properties for instance...I hire people. So that I could say that I spend hours glued to my monitors to trade, whereas with the real estate it runs itself. If we get a repair call, my wife sends the repair man.

My original goal with real estate was to create a secure source of income. I have never viewed trading as "secure". Perhaps you do. I did not buy real estate with the idea that it would appreciate...although it has. I think making money in real estate has been stable, and relatively simple. For the effort expended it was a superior investment to trading. Again, the reason for this is that it took little effort.

At this point I own considerable real estate, much of it is owned free and clear. It kicks out income monthly regardless of what I do. It will be an excellent retirement if and when I ever stop trading...which at this moment I don't plan on. It will also provide excellent income for my wife if something should happen to me. And believe me, she does not have the patience or tolerance to sit at a monitor all day.

OldTrader

 

[OldTrader]

Quote from Cutten:

Everyone with a brain is well aware of the positives of owning your own home, as well as the negatives (maintenance, lower flexibility for relocation e.g. for a new job etc). People are simply saying that these factors have little bearing on *changes* in RE prices. The benefits and negatives of owning RE are priced-in to the market, and are therefore fairly useless for forecasting. The intangibles help explain the *level* of prices, but not the rate of price appreciation (or depreciation).

The pros and cons of owning RE in, say, California, were the same in 1990 as in 1995, 2000, and 2005. Therefore they cannot explain the big price swings from 1990-95, 1995-2005 etc. We must look to other factors to explain the price falls then rises over that time period. Rental cashflows relative to historical norms for an area are a fairly good measure of value. Whereas being able to do your own decoration has nothing whatsoever to do with whether your home is cheap, fairly priced, or overvalued. Home ownership had intangible benefits in Osaka in 1990 - that didn't stop prices of residential RE falling 80% over the next 15 years.

I think you missed my point. I never claimed that some of the more intangible types of factors accounting for the rate of appreciation.

The intangibles (if that's what they are) account for the fact that most people want to own. It's their preference due to all of these intangibles. People don't set out to buy because they think the house is going up. They buy because at gut level, they prefer it.

My father for instance always lost money on houses throughout the 50's and 60's. He was transferred every couple of years, and never had the time in a property to build much equity, and the prices weren't appeciating sufficiently to overcome some of the charges. Nonetheless, he always bought, because he felt that a family should be in their own home. That gut level thing again.

You know Cutten, some of us still buy our cars. They go down in value. But in the end, you have no car payment. If you buy a house, in the end, you have no payment. If you rent, there will always be a payment. And chances are the rent payment will be higher 10 years from now than it is today.

I don't believe that rental values are any sort of measure of value in a single family home. In fact, the appraisers don't use the "income approach" to establish value at all. Reason? Home buyers don't compare to rent, because they want to own for alot of different reasons, some of which are much more intangible.

You guys need to go talk to your wifes...perhaps she can explain it all to you.

OldTrader

 

[Sparohok]

OldTrader,

Interesting stuff. Thanks for sharing your experience.

I personally have nothing against buy and hold investing in real estate or anything else. When I see sufficiently attractive valuations, I have no problem tying up capital in a long term position. I just find it interesting that the wide derision for buy-and-hold stock and mutual fund investors among many traders doesn't seem to carry over to real estate.

Martin

 

[Sparohok]

Quote from OldTrader:

I don't believe that rental values are any sort of measure of value in a single family home. In fact, the appraisers don't use the "income approach" to establish value at all. Reason? Home buyers don't compare to rent, because they want to own for alot of different reasons, some of which are much more intangible.

Virtually all first time home buyers are already renters. When they choose to buy a house they are inherently comparing what they're renting today with what they're buying tomorrow. For that matter, you can barely open the real estate section of the paper without finding an article comparing buying with renting. Who's it written for if nobody compares buying with renting?

The reason appraisers don't use an "income approach" is because their job is to determine market value. Whatever the market would pay, it's their job to report, no matter how far it is from net present value.

Martin