Are you serious? Two years ago, I purchased a townhouse for $10,000 down plus closing costs of $4000. It is now worth $35,000 more than when I bought it (not including the downpayment). So you're saying that I'm unfortunate because I wasn't getting a return on my $14,000? My home equity WAS the $14,000 (technically only $10,000 in the beginning). I almost tripled my investment and quadrupled my equity in two years. I woudn't have made that gain if I didn't make that initial investment in the first place...holding equity was the only way I could make that gain short of an option to buy. And even if we pretend that somehow the $14,000 isn't related to the $35,000, I'd still rather be the guy with $35,000 equity that magically appears for doing very little work, even if the $14000 went no-where. Hey, three years ago I also put $14,000 down on a townhouse that now has increased in value by $55,000. Woe is me? SM
Ok, I'm still confused. Is the reason that the model showed rent increasing only 1% a year because the model was supposed to be discounted back to today? In that case, shouldn't the payments for the owner payments decrease over time in the model because the net present value of each successive payment will shrink because the payment is relatively constant regardless of the rate of inflation? It would still have the same break even point if the payment was constant and the rents increased with inflation. If not, then I still don't understand why rents don't increase at the rate of inflation in the model, because thats pretty much what they do in real life. 9 years ago, the rent at "Unit 1" was $640. Today it is $890. Thats 39% in 9 years or about 4% a year. If it really was 1% a year, and that has been true historically dating back 100 years, then rents would be something like $30 a month because you could probably rent a place for something like $10 a month back in the early 1900s. SM
Your situation is certainly nice, and now you probably have $50k in equity. You show the power of leverage. When I made my statement, I was really considering people who have more equity in their home than this - ie 20-50%. They are losing a bit more than you on lost dividends. A few years ago this was a non issue, as short term money payed next to nothing in yield. Now with it very easy to procure 5%+ yield with relatively no long term committment, the picture and psychology of the market is changing. And perhaps that unrealized gain of $35k may be pressured downward. So even in your great situation of an upsurge in price, your leveraged involvement posts a possible downside going forward. Lets fast forward another year or two, where short term rates might possibly be above or around 6-7%. Would you be comfortable holding on to that home in a likely downward trending market (thus wiping out your unrealized gains), as well as risk lost income in tied up (decreasing) equity during that time? 'Soft landing' is terminology derived by those whose interests it serves best: the Bush administration, the national association of realtors, the entire mortgage industry, etc. Just because its a term thrown around, doesn't mean it will happen. Watch liquidity dry up, and it will be very difficult (especially after transaction costs, maintenance, etc.) to keep your 35% gain. I won't even go into details of how townhouse/condo prices are more volatile than single family homes, perhaps due to their downsides (HOA fees, limited space, neighbors on top of each other, etc). So evaluate the investment not solely from your entry point, but if you had to make the same move (buy your condo) today. Is it a good move to buy the townhouse you own at today's market prices? If you still think so, then hold. If not, then it might be time to move on and take your easy money. That is, unless you would rather rent it out for life. A relatively easy to find 6% bond is double that. I ran a little spread sheet for you. You can adjust it, depending on your rents. I assume you're breaking even at least on your rent (which is a more profitable situation than many is the most overinflated markets). Regardless, I set home values in my estimates to be flat for the next 6 years, and then figured they'd appreciate 2.5% annually after that. I also showed how 0.06 yield compounding annually on $40k you'd cash out with would compare, assuming you had the discipline to leave it alone. Remember, as a property landlord, you're also exposed to weaknesses in local job markets, headaches from tenants, periods where the property doesn't get rented out, etc... At the end of the day, you make out a little more in the long term owning property, and at least you're inflation hedged - ie if rents escalate very much you'll do extremely well. But with everything you get what you pay for. My parents bought they're small house in a suburb of Ohio for $44k in 1979. Now 27 years later, its worth around $110k. And they've probably put as much into it over the years (new roof, central air, carpets, new kitchen, etc. etc.). So the point: there is nothing perfect, and property ownership and landlordship definitely has its downsides. Thats a different story from southern california. But of course, the earlier spreadsheets show the downside of that, and how a flat or declining market possibly kills any reason to enter the market during a period like that, for investment reasons at least. And in my spreadsheet, modify your current property values for the first few years to actually decline, and I'm sure 6% monthly will actually beat the housing - with not a single headache. And if we're lucky, with that perspective, perhaps we'll hit an oil shock just like the late 70s, and eventually get our long term bonds in the 16% range. I'd lock in every single penny I have, and just in case we're worried about the solvency of our government, buy some credit default swaps while we're at it (i'll take a small hit in premium to get those rates on an annual basis for 30 yrs - guaranteed). Let me know how your numbers compare to my shot in the dark analytics. I gave you the benefit of the doubt on your rents being high. I'd like to see what sort of deal you're in. Here in southern california, there are no 160k (decent) condos. I dream of those.
I didn't show much rent appreciation for any specific heavily researched technical reason. The point was two-fold: 1) to offset non increasing prop taxes and other costs (maint/etc) I was too lazy to calculate. (which also appreciate to match inflation) 2) Remember, a house does not get rented out every single day of the year. Things happen - tenant problems, local economy weaknesses, etc. etc. So for the use of the chart with an owner considering buying to rent a house out, this slight discount against appreciation probably gives a more accurate picture of what to expect in real life. and 2a) continuing the point from the opposite perspective, rents do not always appreciate. They stay flat very often, and are more reflective of strength of the economy and local job market. If no one is making any money, rents go down or flatten. If the economy strengthens, the opposite happens. Right now, you can rent a $475k 2 bedroom condo in carmel valley (a very desirable suburb or san diego, next to del mar) for $1400/month. The landlord is likely paying $250/month in HOA fees, $100-$400/month in prop taxes, etc. etc. That leaves nothing left for the owner. So when I talk about lost equity performance, think of the guy who bought the condo when it was built for $125k 20 years ago. Likely, he has $300k (after sales commisions) of equity sitting around doing nothing. Imagine if he could compound that monthly at 5 or 6%. It just doesn't pencil out to hold rental real estate in markets like this. (hell I should rename my handle 'socalrebear'..)
So maybe now, today, this hour is not the time to buy anything in the whole of the United States (that's a pretty ridiculous assumption to me, but let's go with it). At some point the time will come. And when it comes, you'll be able to leverage your equity to make way more than 6%. Here's just one example. I used my secured line of credit (which will give me access to funds up to 75% of my equity) to borrow 50K and put it down on a flip house (which was cashflowing so it could have been used as a rental also). Fixed up the house and sold it for a 57K profit 3 months later. At first glance it would seem that I doubled my money. In fact, my only out of pocket investment was about 700$ in interest, the rest was leverage. So, invest 700$ take out 57K. Not bad ROI for 3 months I would think. Used some of those profits to pay a little more off my mortgage, saving me thousands in interest costs over the long term. Wash-Rinse-Repeat. You really don't need to lock you money for your whole productive lifetime at a petty 6%.
The fact that housing is relatively illiquid runs to your benefit to reduce your risk on your leverage. You timed it well. But lets say you bought today at an inflated price, took 3 months to fix up, and another 3 to sell. By the time you exited, you could only sell for 50k (with at minimum 2.5% commission, assuming you're doing FSBO and buyer is MLS) - less than you bought for. Its easy to pay 2.5% more than you should've. If you sell with a 2.5% commission (benefit of the doubt toward's you), you're down 5%. Add another -2.5% for mark biasing down (very possible in 3 months), and you're at -7.5%, or $52.5k - for a $700k house flip. And lets say you bought at the same 2.5% premium, and because you were stubborn, held out for 1 year because you didn't want to take a loss... it could be even more disastrous. We've all done the same with our options and stock positions in the past. Thats not far fetched -- so you just had good timing, congrats. There's plenty of people in exactly the situation I mention right now. By the way, I'm strictly speaking about certain hyperinflated areas in the states. Certain markets are probably fine to buy - but I assume good 'deals' that can be classified as short term investment opportunities like the one you mentioned are hard to come by, universally. Easy come, easy go. Try the same thing today and let me know how you do.
Scria, Ok, since you put together that spreadsheet for me I'll play nice and concede that the opportunity cost of money tied up in property is more important later on in ownership. However, as I'm sure you know, I don't let that happen. In real estate investing, if you want to make a killing, you keep reinvesting that equity. Once I have enough equity in one unit to borrow against it and buy another, I do so. So my equity is, in effect, always in the early stages. Why let the money stagnate when you can make 30+%? I guess a homeowner could do the same thing. They could take a second mortgage and borrow against their equity to put it into something that will pay them more. Please EVERYONE, understand that this is dangerous and not meant to be funny money for day trading. But if you were well diversified and bought something like high dividend paying stocks, you would be better off as long as your return was high enough. I guess then you would be getting the benefit of leverage and the investement of stagnant funds. Interestingly, I guess a homeowner could even take a second mortgage aftera run up in prices, and buy into some investment that hedges the cost of a collapse in the real estate market...like shorting the builders or something. FWIW, I dream of California wages. SM
This sounds great, ideally speaking, but housing collapses are slow to show since the asset is relatively illiquid. But to borrow against your property, you'll likely pay 7% annually to do it. You'll need to beat the 7% to break even. Take a look at the builders - KBH, Toll, etc. - they're already down to 2004 levels. The REITs will follow, but likely a lot less, as they're numbers are more tied to short term interest rates than housing prices. So its a difficult bet to hedge. And the jury is out on the CME housing futures. Perhaps CME housing futures options (not yet out) will provide enough movement amplification to provide a proper hedge. Furthermore, you don't need to borrow against all of your gain with options, otherwise you'd overleverage yourself and possibly with failed timing miss out on a big drop.
I don't see real estate collapsing but if it does, then just pick yourself up a couple of properties for pennies on the dollar and rent them out for magnificent cash flows. Even in bear markets some things go up (like rents, when everyone is afraid to buy). I think the US has enough immigration and population growth to support a healthy real estate market over the long term.