The money to be made in RE is made by sitting, by SITTING! You have told two stories to illistrate your point this evening, but you havn't realized that in both cases had the property in question been held for just a few more years the investment would have yielded profits. RE is a very tough investment to outperform over time and history has show time and again, that more millionaires are created by real estate than in any other asset.
The Single-Family Home Tax Shelter Myth
- Thread starter Martin Gale
- Start date
The money to be made in RE is made by sitting, by SITTING! You have told two stories to illistrate your point this evening, but you havn't realized that in both cases had the property in question been held for just a few more years the investment would have yielded profits. RE is a very tough investment to outperform over time and history has show time and again, that more millionaires are created by real estate than in any other asset.
Here is a simple model on affordability. 12x (or 1200%) for LA is way off the charts ... 3x to 4x is historical average. And I mean not just for the last 100 years, but back to Roman times.
Right now, it appears personal income must rise quickly to support 2005 selling prices. It looks like that could happen. But, the Fed will make interest rates high if it does.
It looks like OldTrader sees property selling for ~12x rent role in his area. That is historically high also, but (was) supported by low interest rates.
Commercial property buyers are buying at 10x - 12x rent roll on the speculation that rents will rise as more home buyers are forced out of the affordability zone (higher interest rates) and those ratios will go to 8x - 10x as rents increase.
Kind of a catch 22.
Attached is a simple spread sheet.
Right now, it appears personal income must rise quickly to support 2005 selling prices. It looks like that could happen. But, the Fed will make interest rates high if it does.
It looks like OldTrader sees property selling for ~12x rent role in his area. That is historically high also, but (was) supported by low interest rates.
Commercial property buyers are buying at 10x - 12x rent roll on the speculation that rents will rise as more home buyers are forced out of the affordability zone (higher interest rates) and those ratios will go to 8x - 10x as rents increase.
Kind of a catch 22.
Attached is a simple spread sheet.
Ive been watching this thread and joined ET just to comment on it. The answer is complex, and you really have to crunch the numbers in your area to answer this.
In expensive areas, I can prove renting is better than buying quite easily. However, this is only true if you have the discipline to actually invest the difference between your rent and mortgage. Most americans cannot do this, which is exactly why buying is better. A big mortgage is forced investing. However I can, and have. I have both owned and rented, and currently rent because I live in an expensive area of san diego and the numbers dont add up.
Here is a real life example:
Renter
--------------
1200 sq/ft luxury apartment with 2 car garage near the beach, with a nice gym and pool.
$1900/ month
$62,900 in the bank and invests it
Buyer
---------------
I did a search and the absolute cheapest 1200 sq/ft home in my area is $629,000, which needs work (and no where near the beach)
Buyer puts 10% down, $62,900
(Note, this is really not fair since a house as close to the beach as I am would be well over 1 million)
What happens after 30 years?
My assumptions: 3% rent increase a year. 5% avg return/year on the realestate. 8% average return investing in the market. The renter only invests the difference at the end of each year (which loses him a lot of money). I do not include the costs associated with buying a house. I do not include any maintenance at all for the home. I do not include and taxes on the home or any difference in insurance costs.
Im stacking the deck in favor of the home buyer here if its not obvious enough already ;-)
Notes of interest: The amount saved per month goes negative for the renter in year 28 because of the 3% increase.
Final results:
Renter:
-----------------
Total rent paid: $1.08 million
Investments, orig 63K, is now: $2.4 million
Total profit: $1.34 million
Home owner
--------------------
Total mort paid: $1.24 million
Home value: $1.93 million
Total profit: 686K
Now add in the cost to buy the home and maintain it, and the fact you have to spend weekends working on it, and you come out way ahead renting.
Now, given that im a trader and can make 15% a year with my eyes closed, if I plug in 15% instead of 8% return on my initial 63K investment, I end up with: $10.6 MILLION
So what if there is another monster real estate boom in california going forward right now? (Not likely!!!)
In the last 36 years, california realestate went up 8.6% a year (I seem to remember).
Lets plug that in.
Final home value is now: $5.1 million
What return on his investments does the renter need to match this now??? 11%. I can do that easily.
Ill be renting for a few more years, and then ill buy my dream home in cash.
Conclusion: Renting is often the better idea if you have the discipline. Most dont. The big win is my free time not taking care of the house! Hated that when I owned a home!
In expensive areas, I can prove renting is better than buying quite easily. However, this is only true if you have the discipline to actually invest the difference between your rent and mortgage. Most americans cannot do this, which is exactly why buying is better. A big mortgage is forced investing. However I can, and have. I have both owned and rented, and currently rent because I live in an expensive area of san diego and the numbers dont add up.
Here is a real life example:
Renter
--------------
1200 sq/ft luxury apartment with 2 car garage near the beach, with a nice gym and pool.
$1900/ month
$62,900 in the bank and invests it
Buyer
---------------
I did a search and the absolute cheapest 1200 sq/ft home in my area is $629,000, which needs work (and no where near the beach)
Buyer puts 10% down, $62,900
(Note, this is really not fair since a house as close to the beach as I am would be well over 1 million)
What happens after 30 years?
My assumptions: 3% rent increase a year. 5% avg return/year on the realestate. 8% average return investing in the market. The renter only invests the difference at the end of each year (which loses him a lot of money). I do not include the costs associated with buying a house. I do not include any maintenance at all for the home. I do not include and taxes on the home or any difference in insurance costs.
Im stacking the deck in favor of the home buyer here if its not obvious enough already ;-)
Notes of interest: The amount saved per month goes negative for the renter in year 28 because of the 3% increase.
Final results:
Renter:
-----------------
Total rent paid: $1.08 million
Investments, orig 63K, is now: $2.4 million
Total profit: $1.34 million
Home owner
--------------------
Total mort paid: $1.24 million
Home value: $1.93 million
Total profit: 686K
Now add in the cost to buy the home and maintain it, and the fact you have to spend weekends working on it, and you come out way ahead renting.
Now, given that im a trader and can make 15% a year with my eyes closed, if I plug in 15% instead of 8% return on my initial 63K investment, I end up with: $10.6 MILLION
So what if there is another monster real estate boom in california going forward right now? (Not likely!!!)
In the last 36 years, california realestate went up 8.6% a year (I seem to remember).
Lets plug that in.
Final home value is now: $5.1 million
What return on his investments does the renter need to match this now??? 11%. I can do that easily.
Ill be renting for a few more years, and then ill buy my dream home in cash.
Conclusion: Renting is often the better idea if you have the discipline. Most dont. The big win is my free time not taking care of the house! Hated that when I owned a home!
Can you show the calculations where the home value ends at 1.9 million after 30 years of 5%/yr appreciation with a starting price of $629k?
BTW, I think your assumptions listed above are unrealistic but its your post so you can use whatever numbers you want. How long can the rent only increase at 3% year per while real-estate appreciates at 5% per year? Think about it long-term (e.g. 30 years).
There are many assumptions one can make in the BUY vs RENT model that will skew the results in either direction. The challenge I have seen with most models that conclude rent because you invest the difference tend to assume aggressive returns on that money, but in reality, transaction costs are very substantial when working with a couple hundred bucks per month, not many can really achieve thos returns, and they also tend to ignore the impact of taxes, when you do make it.
On the buy side, assuming appreciation rates is where most go wrong. Assuming it is "Free Money" is also dangerous. Realestate is a market where you make money by sitting.
Buying is a good choice for most. It becomes very attractive when you can accomplish any number of things. Buy at a discount to the market. Buy on extremely favorable terms, or Buy a porperty that will require some work, and you are able to put in "sweat" equity. It also is very attractive when you consider depreciation(available if you rent)
Renting is very attractive in areas where rent is at a substantial discount to buying, and you are truely able to get returns on that money. There are a few out there who can do this, but most 90%+, will not be able to do this. For rest of us, the correct assumption is probably a money market rate of return, say 4.5%(until you reach 20k or more in savings). Supporting the rent case, Real Estate has likely made it's move, especially in some recent high appreciation areas, and will likely remain flat or fall by 20% over the next 5 - 7 years, then resume it's normal rates or appreciation.
The flaw in both models is that no one can really know what the future holds. With that in mind, the optimal solution is probably to buy a small 2 bedroom condo rent it out, with your savings from choosing to rent a house rather than buy. Then when you can find a great deal, buy that house. When the condo develops positive cashflow, then invest that money in the market.
On the buy side, assuming appreciation rates is where most go wrong. Assuming it is "Free Money" is also dangerous. Realestate is a market where you make money by sitting.
Buying is a good choice for most. It becomes very attractive when you can accomplish any number of things. Buy at a discount to the market. Buy on extremely favorable terms, or Buy a porperty that will require some work, and you are able to put in "sweat" equity. It also is very attractive when you consider depreciation(available if you rent)
Renting is very attractive in areas where rent is at a substantial discount to buying, and you are truely able to get returns on that money. There are a few out there who can do this, but most 90%+, will not be able to do this. For rest of us, the correct assumption is probably a money market rate of return, say 4.5%(until you reach 20k or more in savings). Supporting the rent case, Real Estate has likely made it's move, especially in some recent high appreciation areas, and will likely remain flat or fall by 20% over the next 5 - 7 years, then resume it's normal rates or appreciation.
The flaw in both models is that no one can really know what the future holds. With that in mind, the optimal solution is probably to buy a small 2 bedroom condo rent it out, with your savings from choosing to rent a house rather than buy. Then when you can find a great deal, buy that house. When the condo develops positive cashflow, then invest that money in the market.
Time for an update. I've revised my model to [hopefully] address the criticisms posted here. The results will be posted below.
Upkeep costs: I originally used $5k/yr based on an article that cited an example of a house bought in 1968 that had since required 3.7 times the original cost to maintain. Most argued that $5k/yr is too high. We digressed into a debate about the cost of a paint job. I've reduced the yearly upkeep cost in my model to $2500, or about $200/month. I find it difficult to believe that amortizing major home repairs and renovations over 30 years will result in a substantially smaller yearly average. In lieu of hard data, this seems like a reasonable compromise, but I'm sure the debate will continue. Find me the data and I'll change the upkeep figure if necessary. (And, no, being a landlord in some particular part of the country doesn't constitute expertise on the national median.)
Apples to Oranges: I had previously compared the cost of living in a house to the cost of living in an apt while omitting lifestyle differences. Most said this was invalid because people don't sacrifice lifestyle if they can afford it. On the other hand, some people prefer the least costly lifestyle. Below, I compare apples to apples. Note: I could not find data for national median house rent; it varies widely from place to place. I have used $1250/mo based on a perusal of craigslist ads for a 3-bedroom house. Find me hard data and I'll change this figure if necessary.
Inflation: I previously neglected the effects of inflation on housing costs. I've now incorporated inflation into the model. I used BLS data going back to 1913 to compute an average inflation rate of 3.41%/yr. I've applied this rate to all non-fixed costs associated with renting and owning, including rent, HOA fees, upkeep costs, property taxes and home insurance.
I think those have been the main points of contention. Remind me if I've missed anything. Lambaste my assumptions. decry my methodology. Skewer me with your critiques. As I've said before, I like being corrected because then I learn something new. Results to follow shortly.
Upkeep costs: I originally used $5k/yr based on an article that cited an example of a house bought in 1968 that had since required 3.7 times the original cost to maintain. Most argued that $5k/yr is too high. We digressed into a debate about the cost of a paint job. I've reduced the yearly upkeep cost in my model to $2500, or about $200/month. I find it difficult to believe that amortizing major home repairs and renovations over 30 years will result in a substantially smaller yearly average. In lieu of hard data, this seems like a reasonable compromise, but I'm sure the debate will continue. Find me the data and I'll change the upkeep figure if necessary. (And, no, being a landlord in some particular part of the country doesn't constitute expertise on the national median.)
Apples to Oranges: I had previously compared the cost of living in a house to the cost of living in an apt while omitting lifestyle differences. Most said this was invalid because people don't sacrifice lifestyle if they can afford it. On the other hand, some people prefer the least costly lifestyle. Below, I compare apples to apples. Note: I could not find data for national median house rent; it varies widely from place to place. I have used $1250/mo based on a perusal of craigslist ads for a 3-bedroom house. Find me hard data and I'll change this figure if necessary.
Inflation: I previously neglected the effects of inflation on housing costs. I've now incorporated inflation into the model. I used BLS data going back to 1913 to compute an average inflation rate of 3.41%/yr. I've applied this rate to all non-fixed costs associated with renting and owning, including rent, HOA fees, upkeep costs, property taxes and home insurance.
I think those have been the main points of contention. Remind me if I've missed anything. Lambaste my assumptions. decry my methodology. Skewer me with your critiques. As I've said before, I like being corrected because then I learn something new. Results to follow shortly.
Results of my revised model -
First, you can't lose by buying:
Buy U.S. House Profit: $299,491
Buy U.S. Condo Profit: $244,757
Buy SF House Profit: $1,208,681
Buy SF Condo Profit: $868,817
Assumptions:
National median house cost: $213k (4th Qtr 2005)
National median condo cost: $228k (4th Qtr 2005)
SF house cost: $633k (4th Qtr 2005)
SF condo cost: $476k (4th Qtr 2005)
30-year fixed mortgage
5.8% interest rate (4th Qtr 2005)
20% down payment
Property tax = $1.54 per $100 of assessed value (nat. median)
Upkeep costs = $2500/yr (debatable)
Insurance = $677/yr (nat. median)
5.36% AVG annual home appreciation (1987-2005 AVG)
3.41% AVG annual inflation (1913-2005 AVG)
Inflation applied to property tax, upkeep costs and insurance
More result to follow...
First, you can't lose by buying:
Buy U.S. House Profit: $299,491
Buy U.S. Condo Profit: $244,757
Buy SF House Profit: $1,208,681
Buy SF Condo Profit: $868,817
Assumptions:
National median house cost: $213k (4th Qtr 2005)
National median condo cost: $228k (4th Qtr 2005)
SF house cost: $633k (4th Qtr 2005)
SF condo cost: $476k (4th Qtr 2005)
30-year fixed mortgage
5.8% interest rate (4th Qtr 2005)
20% down payment
Property tax = $1.54 per $100 of assessed value (nat. median)
Upkeep costs = $2500/yr (debatable)
Insurance = $677/yr (nat. median)
5.36% AVG annual home appreciation (1987-2005 AVG)
3.41% AVG annual inflation (1913-2005 AVG)
Inflation applied to property tax, upkeep costs and insurance
More result to follow...
Ok, I reviewed my spreadsheet.
Several issues came up
1) I actually did assume a 1% property tax rate (californias)
But how I calculated it is wrong. You cannot lower the homes appreciation price every year by including the 1% rate. Doesnt make sense, and besides, unless you get your property reassessed its flat each year at a rate of $6290. So I redid all of this part.
2) Im adding some low maintenance. $1000 a year, since old trader recommended $2000 a year. Maintenance increases at 3% a year.
3) Since I cannot immediately deduct the maint and tax costs from the price of the home and must save it until the end, this is FREE money in the buyers column. To even this out, im allowing the renter to invest the additional maint and tax costs into his savings.
Ok, here are the new numbers:
Renter:
-----------------
Total rent paid: $1.08 million
Investments, orig 63K, is now: $2.7 million
Total profit: $1.6 million
Home owner
--------------------
Total mort paid: $1.24 million
Home value: $2.6 million
Total profit: $1.3 million
Note that cel K1 = orig 62K + savings + maint + tax homeowner had to pay to be fair
Note that cell K2 = =(A2*1.08)+I2+E2+F2
In other words, the original $62,900 times 8% increase and then add in the home owner maint cost and $6290 in taxes he had to pay to make this fair.
Going forward, for example: K3 = =(K2*1.08)+I3+E3+F3
Increase 8% a year and re-invest the main+tax, the I column is the savings difference between rent and mortgage each year, which gets lower each year because of the 3% rent increase.
Yes home values can increase at a different rate than rent. Look at the historical numbers. This has already happened.
Rent is tied more to salaries/inflation.
Several issues came up
1) I actually did assume a 1% property tax rate (californias)
But how I calculated it is wrong. You cannot lower the homes appreciation price every year by including the 1% rate. Doesnt make sense, and besides, unless you get your property reassessed its flat each year at a rate of $6290. So I redid all of this part.
2) Im adding some low maintenance. $1000 a year, since old trader recommended $2000 a year. Maintenance increases at 3% a year.
3) Since I cannot immediately deduct the maint and tax costs from the price of the home and must save it until the end, this is FREE money in the buyers column. To even this out, im allowing the renter to invest the additional maint and tax costs into his savings.
Ok, here are the new numbers:
Renter:
-----------------
Total rent paid: $1.08 million
Investments, orig 63K, is now: $2.7 million
Total profit: $1.6 million
Home owner
--------------------
Total mort paid: $1.24 million
Home value: $2.6 million
Total profit: $1.3 million
Note that cel K1 = orig 62K + savings + maint + tax homeowner had to pay to be fair
Note that cell K2 = =(A2*1.08)+I2+E2+F2
In other words, the original $62,900 times 8% increase and then add in the home owner maint cost and $6290 in taxes he had to pay to make this fair.
Going forward, for example: K3 = =(K2*1.08)+I3+E3+F3
Increase 8% a year and re-invest the main+tax, the I column is the savings difference between rent and mortgage each year, which gets lower each year because of the 3% rent increase.
Yes home values can increase at a different rate than rent. Look at the historical numbers. This has already happened.
Rent is tied more to salaries/inflation.
If I used Martine Gales researched numbers for 3.41% for fixed cost increases/rent increase and 5.36% increase for realestate, and a 20% down payment, we get this:
At 20% down, they are about even.
Most people in california dont do this though. They put 0 zero down using interest only loans, which skews the numbers in favor of renting even more.
At 20% down, they are about even.
Most people in california dont do this though. They put 0 zero down using interest only loans, which skews the numbers in favor of renting even more.