HP Bubblesitters: What do you pay in rent today, versus what would your monthly ownership cost be if you bought it at the peak? For owners - same drill - what would new buyer's costs be versus what would it rent out for?
That simple equation will tell you how far your market has to (and will) fall. This is simply the price/earnings (P/E) ratio of houses.
((ownership cost - rental income) / ownership cost) = price decline needed)
Example (here's a calculator too). Check my numbers, but also take it for a spin on your own place
My old Tempe condo:
Valued at the peak at $320,000. 6% 30 year fixed no money down = $1,918 P&I. Add $220 condo fee, $200 taxes, $200 PMI, $200 maintenance = $2,738 monthly ownership cost (for new buyer). Subtract tax savings (1800 interest per month x 12 months = $21,600 * 25% bracket = $5,400 or $450 per month) = Total ownership cost after tax of $2,288
Maximum rent = $800 per month
$2288 - $800 = $1,488 monthly cash flow loss
To get back to where rental income = monthly costs, condo would have to fall in value
1488/2738 = 54% price decline. $320,000 * 46% retained value = $147,200. Yup, that's just about right.
If you bought the place for $147,200, you'd be cash flow positive or neutral. And that's called real estate investing 101. No matter what David Lereah or the 24-year old iamfacingforeclosure.com kid think. I'd like someone to take this example or similar and go make offers in Phoenix, DC, Boston, Vegas, etc. Oh, man, the look on homedebtors' faces would be precious.
As you can see in this example, either price has to drop dramatically, or rents must increase like crazy. I put my bet on prices dropping, since flat to declining US incomes plus dramatic new rental unit supply mean rents will not go up for a long, long time.
October 09, 2006
HousingPanic Stupid Question of the Day
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38 comments:
(I don't have any rental property investment experience.) Does the rental investor 1) put nothing down and 2) expect his purchase to be cash flow positive right from the start? I can see structuring the purchase so it's cash flow positive by putting enough down and then forecasting some kind of acceptable return on equity before moving forward with the deal. But expecting a positive cash flow from day one on a nothing-down purchase seems a little unreasonable. Or is this what rental investors expect?
Yeah, I noticed that ratio going through the roof a few years ago. I bought a duplex about five years ago for $72,000, it rented for $900 per month. I started looking for more a few months after that, but could never find anything that would come close to paying for itself in near the same amount of time. Nowadays, lol.... forget about it.
Keith,
Your analysis is so good, so sound that there shouldn't be any need for further comment.
But I won't let THAT stop me from adding my two cents.
The only small modification that I would add is that typically when renting any item (car, furniture, appliance), there is typically a small premium paid for the convenience of renting.
How much such a premium should apply to real estate is subject to debate. However, I would not be willing to pay more than 10% over so-called "purchase" costs for the flexibility and peace-of-mind in terms of no maintenance for renting.
OT but....
I have an idea for a new TV reality show (yeah I hate them too).
We'll call it "Save the F**ked Borrower"
A team will go out in search for really REALLY desperate home owners who need to sell their houses.
The producers will say sure, we'll buy your house - BUT, we get to humiliate you on TV.
So, for example, the desperate seller has to sit in a chair in his/her driveway and get tormented by ________ (fill in the blank).
I, personally, think they would have to sit there for at least 60 minutes while people with bull-horns chant (think Cartman from South Park) "ni-ni-ni-ni-na-na"
AND if the seller freaks out during this 'time period' they lose, and the show doesn't buy the house!
I’m thinking Arizona, Florida, or California would be a good place to look for ‘contestants’
The other side of the coin... What if the rents increase as longterm interest rates increase? There are two ways for the numbers to adjust.
What if a housing shortage is caused by tightening credit? What about builders not building into a recession?
A housing shortage due to Buyer's being unable to borrow money on still expensive housing. The banks move to "funds available" loans. Investors raise rents because an increase in property taxes.
Housing prices will certainly drop in some markets. But, I can see rental prices increasing too.
I'm paying 1200/month for a home that sellers would ask (not sure if they'd get it) 575k-700k. I figure I am making out a lot better right now.
jt
In Bangalore, India, the ratio is about 300.
Three bedroom condo rent = $350/month
Condo price = $ 1,10,000
real estate 101: rents still have to relate to supply and demand. Our landlord decided to raise rents when all that stuff was hitting the news about how rents were increasing because fewer people were able to buy. We simply moved to another rental. I had difficulty scheduling a final walk-thru because so many others were doing the same thing. I notice he now has big signs out and balloons advertising rentals. Having these units lie empty is going to kill any kind of rent increase he was hoping for. I think he made a mistake thinking the market could bear a rent increase.
My landlord purchased the condo that I'm renting in August 2005. I rent the condo for $1,325 a month. This condo costs the owner $2,100 in mortgage, condo fees, taxes and insurance. All of this information is available on-line so I'm very sure about the numbers.
I was lucky and sold my home in February of 2006 (put it on the market August of 2005). I'm very happy with my decision to rent.
Yeah and all that crap about rents going up because of the increase in demand is nothing but a load of crap here in DC. Everyone seems to overlook the fact that when the house can't sell, it gets rented. So, what I have seen (I was previously looking) is an actual decrease in rents- and where you don't get the decrease, you get a much better place.
"Does the rental investor expect his purchase to be cash flow positive right from the start?"
For professional "investors" the answer is yes! For amateur real estate speculators, it's a "maybe". With a 20% down loan, there should be positive cash flow and a relatively high cash-on-cash return on the down payment. The use of leverage through the mortgage should allow a real estate investor to achieve a higher return on his equity than he could achieve through a "riskless" (T-bills) investment. The irrational real estate market in bubble areas the last few years has made this nearly impossible, this is why most veteran income property investors haven't purchased any properties for several years.
If you look at multi-family commercial real estate sales pitches, you'll see that brokers have had to assume 40-50% down in order to achieve the positive cash flow, and have completely disregarded the opportunity cost of putting that much down on a property. Even with these enormous down payments, multi-family properties in SoCal are ekeing out 5% cap rates and cash-on-cash returns of 2%. This is certainly not worth the risk, (remember that leverage works both ways) and in an increasing cap rate environment, anyone buying at those multiples will be underwater in the near future
I rent a condo in Los Angeles for 2k/month. These were selling last year for just over $1M. Three units in the building have been for sale all year with no buyers. The Realtors seem to have given up on holding the weekly Open Houses for them, but the signs are still up.
You F'ing morons
Rent has increased 6% over the last year with another 6% coming this year.
I thought you all believed house prices went down?
Run the real math with the numbers you have been preaching
Long time reader, first time commentor. We sold our house in Portland in June 2005. We bought it in 2000 (3bed 1.5 bath) beautiful home in great neighborhood and our monthly payments for mortgage (owed $220k, bought for $270k), insurance, and taxes was $1750. After leaving the country for a year we came back this summer, June 2006 and found a house to rent in our old neighborhood for $1550. Its a 3 bed 2 bath plus office home. Right now we could not buy a similar home and pay the same amount of money that we did in our old home, or on our current rental. Though we want to buy and have been looking, it's not promising. I'd be happy to pay $2000 a month piti but dont know if I'll find that right now in the neighborhood we want to be in. We dont want to buy at the top of the peak, but how many more years before prices adjust???
keith,
this calculation is totally wrong.
Here is why: your condo is generating about 1500 $ a month of loss comparing to rental, isn't it?
So in a year you loose on owning property about 18k$.
No as mortgage is for 30 years you can save during that time 18k*30=540k$ - here is your gain
but after 30 years you will have you own house as mortgage is finally paid.
Lets assume that during that time there will be no appreciation in any class.
So you have a house worth 320k$.
So you real gain is only 540k$(renting) - 320k$(owning) so in reality renter will gain only 220k$ in 30 years so it is about 7k$ a year or 600$ a month.
Well, I am also in renting team but to be honest you shout that americans are idiots and cannot count but your calculation is also utterly wrong
For an 1100 square foot two bedroom apartment in my (vintage, courtyard, west of Fairfax) building in West Hollywood:
To rent: $2200 - 2400 a month
Carrying costs (HOA plus mortgage) of the lady who just bought one for $580,000 (assuming a $100,000 downpayment) roughly $3400 a month.
Our carrying costs (we bought in 1999 and took out a 15 year mortgage): $1700
I have another California example that gives you an idea of just how F****D new owners are in California. I rent an apartment on a street where similarly sized houses would have a $4,000 per month rent, plus $700 in property taxes, say $400 in PMI and alot in maintanence cause the houses are old. That's over $5,000 versus the $1,250 I pay in rent. Oh yeah, and my hot water is included in my rent and we have a pool, neither of which would I have in a house in this area.
John,
If you do not assume price depreciation your calculations are also wrong
anon,
of course it is wrong because propably there will be some interest on saved money, plus some appreciation on home (within 30 years you can bet on it, specifically if dollar will tank what in such span of time is a obvious thing), etc.
My point was to show that calculating a way keith did is not right because you forget about a home value and assume that mortage payment is only interest payment.
Just wanted to point it to some of you who (looking at keith calc) would never decide to buy while sometimes it is not that stupid
Keith,
Your calculation is wrong.
If you buy the same condo at $147,200 instead of $320,000. 6% 30 year fixed no money down = $882 P&I. Add $220 condo fee, $200 taxes, $200 PMI, $200 maintenance = $1,702 monthly ownership cost (for new buyer). Subtract tax savings (600 interest per month x 12 months = $7,200 * 25% bracket = $1,900 or $160 per month) = Total ownership cost after tax of $1,542
Maximum rent = $800 per month
$1542 - $800 = $742 monthly cash flow loss
This should have been zero if you were right. By the way, are you renting now?
I sold my rental in April because I got 273 times rent. To own it today would cost twice what it rents for. My plan is to buy back 3 just like it at the bottom from these procedes at the top. I didn't want to sell but it was insane to leave that much in one declining asset.
The other side of the coin... What if the rents increase as longterm interest rates increase? ... What if a housing shortage is caused by tightening credit? What about builders not building into a recession? A housing shortage due to Buyer's being unable to borrow money on still expensive housing. The banks move to "funds available" loans. Investors raise rents because an increase in property taxes. .... But, I can see rental prices increasing too.
+++++++++++++++
I think it's inevitable that rental prices will increase. Therefore, I expect to see a LOT more homelessness in our urban centers in the years ahead.
I sold a bunch of my rental property last year for over $1 million. The profit was $500k. I had owned these for 9 years. Real estate is a great investment. But, you need to buy it right and in the right location. The rentals I kept are 3-4 bedrooms, 2-3 baths, 2 car garage, around 2000 sq. ft. and with large level yards. The few rentals in the area are rented in days, not weeks or months.
I do see rents increasing once supply decreases. Everyone and their brother tried and most failed at RE investing in the past 2 years. Most have now sold or are attempting to sell. Once inventory reaches supply the worm will turn. Renters beware, get your tents ready and mark your spot.
A few weeks ago, somebody on HP posted the following equation, which in this case nailed it:
“Historically, housing cost hover around the 8 to 10 times rental income mark.”
For example, $1,080 * 12 months * 10 = $129,600.
This amount is within $5k of what I paid for my first house in 1997, then moved out of in 2001 and charge $1,080/mo rent. I have not raised the rent because rental prices have remained relatively flat (here in the Seattle area) these past few years. The tenants are excellent renters and I would not want to give them a reason to move.
Currently I pay $40/mo out of my own pocket each month to make up the difference between the rental income and mortgage payment. Since this is building $500 equity every month, being ‘upside down’ here is acceptable. Also, with the tax deduction voodoo, the $40 probably goes away in April.
Due to the deflating housing bubble and with the likelihood of many “impossible-to-sell” houses & condos being put onto the rental market, it appears that it will be a renter’s market for some time and that rental prices will remain flat here.
-Mammoth
portland, or example: brand new 2BR/2BA condo bought in june '06, w/den/office, 1700 sq. ft, 2-car gar., primier neighborhoods in nw portland: rent $2200. nada. $2000. sorry. $1950. still no renter. $1850. lookers, but no takers. $1795, no renters yet.
purchace price: $419.9K. 20% down, 5.25% 1-yr adj., total PITI and HOA: $2775. can't rent the brand new unit for 65% of carrying costs (neither 80% after deductions, not counting depreciation).
assuming that it rents at somewhere at the $1795 level, how much do rents have to rise to converge with carrying costs at flat prices? ~55%. if rents were to rise at 4%/yr., it will take 10 yrs. for rents to catch up to flat prices.
how much would the price have to fall to converge with the rents? ~35%.
at a 4% rise in rents for 5 yrs., how much would the price have to fall? ~20-21%.
i suspect that this is a reasonable scenario to expect for most areas of the US. it sounds benign, but we're talking trillions of dollars of net household wealth lost, along with a similar amount of consumer spending in the next 5-10 yrs.
face it, we're fooked.
We dont want to buy at the top of the peak, but how many more years before prices adjust???
hamsterhouse, how old are you? do you remember the early '80s and early to mid-'90s? i am estimating that on the west coast it will take 7-10 yrs. for prices to decline and bottom out, if not in nominal terms than adj. for inflation with nominal prices being flat to lower through the early to mid-'10s. if i'm right, you won't even give it a second thought about buying any sooner than after '10, as we face an "adjustment" period to real estate, consumer spending, incomes, employment, and gdp growth such as none of us as lived through.
rent, as i have been doing in portland at 60-70% of mortgage costs. rents haven't gone up appreciably in portland for 5-6 yrs. you are the leading edge of a secular trend of people cashing out. enjoy it. relax. appreciate your good fortune.
don't rely on mortgage equity for "savings"; it's not yours anyway, really, as you have to borrow your own money from the banker to realize it or sell the house and cash out.
the 9-20%/yr. roe people have been getting during the bubble is history! forget about it. bankers have reduced the growth of real estate loans from 14-15%+ to 5% in the past 6 mths., with the rate decelerating still further in the past 2-3 mths. for foreseeable future people will be lucky to see equity grow by whatever they're paying down their debt, i.e., 2-3%/yr., which is one definition of deflation, especially if i'm correct that the 5- and 10-yr. treasury yields are headed for below 3%. in this scenario, you will get little tax benefit from paying interest on a mortgage with rates so low and flat prices, and you are not likely to get any or much inflation-adj. appreciation from borrowing a pile of money for a mcmansion.
chill! kick back. don't be a debtor in a debt-deflationary cycle. save money. cash will be king. enjoy your status. renters are the smart ones at this pt. in the long cycle.
I'm a renter now, after having owned rental property for the past 14 years and my own home for the same period. At the height I had 12 rental properties, all but two of which were sold between March 2005 and last month--the other two are still for sale. I'm now a "bubble sitter" waiting for prices to come down before buying a larger, fairly permanent single family home. I did well in the bubble. I'm sitting on more than a million dollars at age 34.
I think rents are coming up more than we might like to admit. The nice townhouse I am now renting in a lackluster San Diego suburb sold for about $500K at the peak. Right now to move them the neighbors have dropped their price to about $420K. I am renting for $2000. Two years ago the rent might have been $1500. I shopped around a lot before finding this place because there are many other pricier rentals.
The point is: both sides of this unprecedented housing price debacle are moving. The rents *are* coming up; the prices *are* coming down. Somewhere around $380K, the place I'm renting actually makes reasonable sense to buy, unless one predicts that the trough will be lower than its economic baseline simply because people become afraid to buy houses after losing money on them (which indeed may happen).
I think your analysis is sound, but I don't think it helps the case of those of us pointing to the bubble to use unrealistically low rents and housing prices from the "peak." The rent/buy decision still tips firmly toward renting in most markets now, but if you're waiting for things to fall yet another 40% I think you're going to be waiting a long time...the rents in at least San Diego are supporting prices higher than that strictly on the cap rates.
Keith, I'm a bubble sitter myself, but to be fair your analysis has left out one aspect in the owner's favor. At some point after getting through the opening years of their mortgage (30yr fixed with 20% down) some of their cah flow is going toward building equity in their home, not through appriciation but because they are paying down the loan's principle. Of course this assumes they are paying debt down faster than their home is losing value.
Of course this comment only applies once RE bubble has disapated.
Of course this assumes they are paying debt down faster than their home is losing value.
or that they are paying down debt faster than their equity is contracting. or, that they have not borrowed to 100% or 125% LTV and spent the equity on a big-screen tv, new bmw, a boob job for the mistress or mrs., and the $50k granite and stainless steel kitchen THAT I CAN'T STAND!!! whose idea was it to fill every kitchen in the country with this crap, anyway?!
Keith you need to be careful here. Rents are rising at a faster pace than homes are falling.
I don't think homes will go DOWN in price to make rent vs own equation work.
Rent prices will keep goin UP until they match housing costs.
this is all one big inflation push. real rates are negative. Bernanke paused rates during an inflationary acceleration to bail out homeowners -who control politics and society.
renters don't make laws. renters don't serve on the FED board.
those who profit from inflation control inflation
you seem to fail to see this aspect
look at TOL, BHS, DHI -stocks defenitely bottomed IMO
I agree the rent equation is all over the map. I can't get my parent's to sell their dump in California for a mil (not that it matters, paid for and they are old) so even though I love Austin I've considered moving back to the bay area to be near them before they die. Drawback? I can't come close to renting what I live in in Austin for my mortgage. I can't really find many places I would live in, unless I left my family in Austin and rented a small 1 bedroom or efficiency, that wouldn't cost me $2100-$4,000 a month. I have yet to see rents falling in San Jose, Los Gatos, Monte Sereno, Almaden, Monterey, hell even Gilroy and Salinas have rents I wouldn't pay.
Phoenix? I think you definitely can rent a descent house for less than the equivilant rent if you look at the upper-mid to high price range. For dumps, maybe even.
In Austin, again all over the map. Anything west of I-35 and you pretty much pay $1600-4,000 a month. East of I-35 you can rent for $950-2,000 for a descent house. Downtown, expect at least $1 a sq ft up to $1.85 a sq ft, so slightly less than if you bought.
Vancancy rates are falling on quality rentals. If people want cheap houses or rent, move to the south side of San Antonio or San Angelo or Abiliene or Amarillo. And cheap rent in Dallas? They'll eat you up with high auto insurance and high cost of living for other items.
I guess I'm slanted because until last year, I've never lived in a bubble city (Phoenix was the first...and if you take the low taxes into effect it really isn't as bad as some other areas).
I think that a lot of the bloggers here must be single and only need a 1 bedroom or efficiency to live in. Try renting a descent house in a descent neighborhood with descent schools and you'll find rents to be a lot higher than that $650 a month studio.
other rental advantages:
no repair costs
no tax raises
move when you want with 30 days notice in the case of bad neighbors, job or marital change or any other reason
after 31 years of home ownership I switched to renting 2+ years ago in Denver..renting a terrific apartment for $1050/month, similar condos, same location $250k and up
just signed 3rd 1 year lease, no rent increase so far and vacancies in Denver are still around 8% with lots of new construction adding new units to keep things from going up too much for a while anyway
I always believed in owning my own place, but for now renting makes much more sense, at least in my situation
neighbor house, flipped 3 times in six years for the tax free capital gains, manipulated prices to where cash, loosing purchase power or inflation of 300% , or an intrest rate, from the price stabilization fed, that is no way near sustainable at 15% to recoup dollar value, 30 years to break even? with 60% of the population at retirement age!
same 87 thousand dollar house selling? for 375 thousang, renovated into uglyness!
$4 cup of coffee, only for some, only to some
you should also subtract out principal paid, so rent and interest, taxes, and condo fees are compared to rent. It still doesn't look great, but principal is NOT and expense, it is (in theory) your money that you could monetize.
Jacking up rent prices.
I'll easily raise the rent on investment houses I want/can sell. My equity position is 55%. The tenants can either pay more or get out. Rent creep will increase as the number of rental homes decrease and interest rates rise. Very plausible for renters to be stuck renting for decades. It's all about timing. Low interest rates will vanish in the next year or two. Home prices will drop for Sellers having to sell into a high supply market. That won't last forever.
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