Might I add...the implication of a PV of $50k, on a $100k property, is that the $100k property 'really', based on the long-term fundamentals, is close to 100% overvalued based on discounted cash flow analysis. Usually when it comes to investing, people try to buy present-value dollars worth of discounted future earnings for mere dimes or quarters. Not the other way around.
Woohoo. Ok, I'm gonna try to reply here. Probably only interesting to your or I. I figured out some of the confusion is coming from our context. I was soley discussing an owner occupied dwelling. So I'll clarify here (see below). But it happens all the time. You buy a house (to occupy) with 3% plus closing costs, and you're levered at about 17 to 1. And they give you the owner occupied rates of 6.5% fixed. Right now, you can get about 5:1 on investment property, but you can do "no money down" deals and theoretically have infinite returns. I once walked away from a closing with money in my pocket, but that makes me sound like Carleton Sheets and those days are over for now. The 6% was intended to represent the opportunity cost. My statement was confusing and poorly written. Moving on, the interest rate spread for different amounts of leverage is very small. If you leverage at 17 to 1 by putting down a 3% down payment, you may pay only a 1/4 of a percent more than if you put down 20% and you're leveraged at 5:1. It is interesting that if you seek leverage, there is little disincentive not to lever huge. Here I was talking about owner occupied. Agreed that this would be not so hot returns for rental properties, but owner occupieds can lever much more, like 17:1. Cash needs to flow better for an investment property. Borowing $50K to fund a $150K stock portfolio is more dangerous than leveraging 17:1 for a typical home purchase IMHO. Stocks move backward 33% all the time, but home prices seldom do...at least in the long-run. You only realize a price decline in real estate if you sell. If you're owner occupied, there is no reason to take a loss unless you move, get divorced, etc. Yeah, there is risk involved. But with rental property, when prices decline, the demand for rental housing most often gets better. Again, no reason to sell. Also, bear in mind, there are no margin calls in real estate, but you can get a margin call if you leverage high. Correlating incomes and rents doesn't make sense to me, because if incomes go up, rents can actually go down because more people buy homes so landlords compete for the remaining tenants. The reality is that rents have been depressed for years because it was so easy to get a loan and buy a house. Now that worm has turned, and people are less inclined (or able) to buy a house we're seeing it in rising rents. This is actually making rental properties more attractive and I've noticed that the smaller houses more typically befitting rental property are actually rising in my neck of the woods based on landlord demand. I'm not saying that housing prices can't fall 50%, but I think that these ratios will close based on movement of other variables. Like wages going up, or rents going up. Or perhaps even rising rents creating more demand for purchases. You realize that my "offer" was the net effect of buying a house? You make a downpayment, and lock into a payment for 30 years. You can sell the house at any time and take back the downpayment, plus the leveraged returns on that investment. When you buy a house, you can leverage your downpayment at 17:1 to 10:1 depending on right tolerance and reasonably expect returns at the inflation rate on the asset, which is a great ROI. You don't have to worry about margin calls, and the money you borrow for the levered portion is at about 6.5% which is a screaming deal. You generally can sell when you want to, unless something happens in your life that would likely require you to sell your other investments at a bad time too (job loss, divorce). If you're a landlord, right now, you can't lever your money as well as you used to be able to. 5:1 is more typical now days, and this may mean a final yield of only 15% to 20%. However, you do get an enormous tax benefit associated with purchasing rental properties, and you can increase your cash flow every year which eventually more than offsets the payment. You can manage the risks with diligence, and sell when you want to. SM
That "major drugstore" (I am assuming you mean Walgreens) has activities that can provide a 15%+ ROE. Long-run RE returns are similar to long-run long-term bond yields, ie: around 7% or so, give or take a little bit. The CFO is acting rationally by dumping lower-returning assets off the balance sheet and using the proceeds to invest in activities that can generate much higher ROE's. The 'joke' really is on the buyers of the REITs or the underlying real estate, who get to accept a much lower return on their investment, for taking all of the underlying risk inherent with debt and leverage. Most "Joe Blows" have the tools to make 10-12%/year in the market by simply buying an index fund from Vanguard or wherever. And thats year after year after year, not some one-off short-term artifact of P/E multiple expansion that has been seen in the past few years because of rampant over-printing of money and poor allocation of capital by the American (and worldwide) investing public. Exactly, we're talking more like 8-10% at best if you apply an insane amount of leverage to most currently available commercial properties. Why bother with that when you can buy the stock market with no leverage and achieve the same returns? Its irrational. Okay.....so I assume you've maxxed out every credit card, margin account, payday loan, etc. possible, with an interest rate under 30%, to capture these opportunities, right? Good luck with that....
No, just put 5% down on my house. Fixed rate for 30 years. With closing costs, I'm in it only 8% of the home value, so back then, I was leveraged at about 13 to 1. As long as the house continues to increase in value at the inflation rate, I continue to make more than 30% on my downpayment though it diminishes over time if you don't leverage up again. I've been there for 10 years and it has more than doubled in value, but I did have to fix my air conditioner a couple times. Of course, if I was renting, my rent would have doubled, so my payment is half what I would rent it for... SM
Generally speaking, this is correct and renting is usually a poor choice. Generally, the only reason to rent is limited access to capital. However, in much of America and indeed in most of the world today, you can rent properties for <i>far below</i> the mortgage payments, less than half in many cases. You can rent properties at P/E ratios of 30 and higher. Your argument is based on a premise that simply does not hold across most real estate in the world today. Market forces will doubtless correct that imbalance and restore your premise, indeed they are in the midst of doing so as we speak. Nonetheless that doesn't change the fact that today, your premise is faulty. Anyone who argues that renting is <i>inherently</i> superior, as this author seems to be doing, or that homeownership is <i>inherently</i> superior, as you seem to be doing, is falling victim to ignorant dogma. There is always a price where buying makes sense and a price where renting makes sense. Ignore conventional wisdom. Pay attention to valuation. Some day buying property will once again be rational. Today, in much of the world, it is not. Martin
Must agree, I moved to Europe and liquidated a majority of my real estate assets in the US just prior to the market softening. I am currently renting, due to the tremendous disparity of land values to rent in Paris and my investments provide a much greater return than I would realize purchasing property at this time. I intend to re-invest in the US property market at an appropriate time, but will continue to rent in Paris, until a price correction is experienced in the French real estate market. As in the stock market, price determines your entry and exit.
No. I wasn't saying that it is always superior. I'll concede that there are short-run periods where renting is better. But in the long run, in the U.S., buying is better. I do not believe there is any point in time, where there is at least 7 or more years after that point, where buying wasn't a better investment than renting. Even if you shrink the time horizon down to 3 or 4 years, I think you'd have to choose really carefully to find a point in time where purchasing wasn't a better deal. I am referring to purchasing property over time payments...not outright...so that you get the benefit of leverage. Given that there are so few time periods when renting is better in the long run, and given that interest rates are very low compared to what they have been in the last 20 years, and further given the fact that sellers are a little fearful because of excess inventory, I wouldn't bet that now is one of those times that one would be better off renting. I don't think that mortgage payments (note that I did not say prices) will be much lower going forward, whereas rents are rising fast. If you rent right now to save a few dollars so that you can invest them at 12%, you may be risking the possibility to lock into the lowest mortgage payments you'll have access to over the next 30 years in the face of an (eventual) healthy housing market, a shrinking dollar and rising rates. I think the "rent and invest the difference" concept is the wrong advice at a very wrong time. Take it for what its worth... SM
Only given the right entry point, the right initial valuation. If houses are sufficiently expensive relative to rent, buying may never break even. Based on current housing prices and rents in my neighborhood in California, financial analysis involving generous expectations for home price appreciation show break even after 20+ years, not 3 or 4 or 7. Only slightly less generous assumptions result in no break even point ever. Your generalization is usually right, and I'm sure there are places in America where it is true even today. But to say that it's always true regardless of valuation ("In the long run, buying is better") is a blatantly false. That's important because right now much of the US and much of the world is going through one of the rare exceptions to your rule. Martin
Ok, see the attached (below) I did an analysis of my own. To make the numbers simple for me, I assumed that there was a $150,000 house. (I know, they don't exist). Anyway, the house reached a value of $150,000 before the crash, and dropped to a price of $107,527. So, if you paid a 3% downpayment and closing costs, you'd borrow $100,000 to procure it. Might be an error in there, but the numbers are reasonable. I then figured out the P&I on the note, and added in a number for the cost of insurance and taxes. Focusing on the 6.5% note, I calculated the payment as $832 including $200 in escrow, and I assumed that the rent would be $700 now. That implies a $750,000 house today (which was probably a $1.1 million house before the "crash") would have a rent of $3,500 today. I then compared banking the downpayment savings of $7,527, plus all subsequent savings on rent. Rents and the value of the house are assumed to increase at 3.5% a year. Note that this implies that the market price of the house never recovers. To ensure fairness, I even assumed that the housing prices remain stalled for another year. Then I calculated the equity of the house, based on a 3.5% growth rate, less the amount owed. For the amount owed, I assumed that the balance declines by 1% a year. This is conservative very, especially over the long term. Based on these assumptions, the crossover point is just after 3 years. The crossover point will arrive faster if the housing prices rise more than 3.5% after the first year (any type of recovery), mortgage rates rise, or rents rise faster than 3.5%. Note that if either of those things occur: any type of recovery causing a rise in housing prices after one year that exceeds 3.5%, an increase in interest rates, or rents rising faster than 3.5%, you would be paying the consequences of your actions for 30 years. It would be interesting to do a sensitivity analysis with that. So though the crossover point is 3 years, that does not mean that you could wait 3 years before purchasing in this scenario. In fact, the rate of return of a house purchase is greater in year two. In other words, in the second year, the rate that your networth improves is higher with the house purchase...but you're playing catchup. This is almost exclusively due to the fact that I held the housing prices stagnant for one year before they rose 3.5% in the following year. If they actually bounce back, renting is a big, big loser. So perhaps renting makes sense only while the market is stalled. But it's risky. If I did rent, I'd go month to month and watch prices like a hawk. SM
Smart Money, part of the (major) problem with your analysis is that you haven't included the maintenance costs on the house, that you appropriately should be subtracting from the net rent yield. These costs are borne by the homeowner or the landlord, but are included as part of the gross rent paid by the renter. Also, rents rising at 3.5% is a bit on the overly optimistic side unless you have made, and continue to make significant improvements to the property (again, more $$$). Case and Shiller found that houses, properly maintained to original specifications, only appreciate at the rate of inflation, the implication of which implies that, in the long run, rents only rise at the rate of inflation. Based on historical relationships between prices and rent, or price to 'earnings' (earnings being rents net of operating costs, natural depreciation, etc.), houses are apt to drop a lot more than just 20 or 30%, or alternatively, those rent increases you are counting on just won't materialize as housing stock, on the whole, has been overbuilt, leading to excess supply relative to demand. Further, while you are willing to step out and leverage a house 15X (good luck doing that nowadays for a favourable interest rate), you seem to be unwilling to leverage stock investments, which really is unfortunate because its not comparing apples to apples. I agree that traditionally owning has been a better deal overall, and in the long run, should be less expensive than the alternatives, because landlords (rationally) will always demand some sort of return on their labour and risk. But there is a time and place for that, just like there have been good times to own tech stocks, and bad times.