May 26, 2006

The Unavoidable Fact About Real Estate

Forbes takes a look at the returns on housing. “Evidence abounds that the national housing craze is nearly over. You can prosper in such a world. As a first step, figure out how much investment reward a property is generating compared to other properties, and also versus other types of investments. That involves calculating what’s called a ‘capitalization’ rate.”

“Now here’s the unavoidable fact about real estate, especially residential: In almost any hot market, its cap rate is low. Suppose you wanted to rent the 940-square-foot bungalow at 1149 Grant Avenue in Venice, Calif. Since L.A. rentals are plentiful, this tiny house will gross only $2,200 a month, or perhaps $1,450 after operating expenses. Built in 1940, elsewhere this would be a slightly shabby starter home.”

“But the famous surfing scene at VeniceBeach is a mile away, so the market value of this house is $730,000. This makes for a slim cap rate of 2.4%; measly, but about par for Los Angeles.”

“‘Rents are nowhere near where they’d have to be to provide adequate income for a new buyer,’ says Bruce Huntley, who manages 1,500 apartments in the area. Prices in Venice are up threefold since 2001, while rents have only edged up with inflation. Sell and put the money into stocks and bonds.”

From Rich Toscano. “Even as San Diego home prices headed to the stratosphere these last few years, local rents grew at a fairly subdued pace. (This fact should, but apparently does not, cause people to doubt the fundamental underpinnings of the housing boom; but I digress!) The end result is that it costs quite a bit more to buy a given home than to rent that same home.”

“Friends of mine recently moved into a single family home that was purchased just a few months back. They pay $1,900 per month to rent a home that was purchased for $535,000. First we will assume that, had our friends purchased the home themselves, they would have financed the entire purchase price with a 30-year mortgage at the most recent average rate of 6.6 percent. For simplicity’s sake, let’s just say they got that great rate on the full loan amount.”

“If these folks had purchased the home in the manner described above, they would have been responsible for the following monthly outlays: Mortgage principal: $474. Mortgage interest: $2,943. Property tax: $490. Insurance: $100.”

“Once we make (some) final tweaks, we see that the purchaser of this home would be divesting himself of just a bit over $2,500 per month. In addition to the assumption of very favorable tax and insurance rates, this $2,500 per month figure is predicated on the idea that the 80-year-old home will require no maintenance.”

“The renter who is shelling out only $1,900 each month seems to be getting a deal. Even under our unrealistically cheerful assumptions, it would cost 32 percent more each month to own the place than to rent it. Put another way, the buyer would be out an extra $7,200 each year.”

“The standard objections to renting make little sense in a situation like this. Take the old saw that ‘renters are just paying their landlord’s mortgage.’ In fact, they are not coming close. They are only paying enough to cover the after-tax mortgage interest, hardly the renter-to-landlord transfer of wealth that the saying would imply.”

“Similarly, renters are often told that they ’should be building equity.’ But who is the one building equity in this situation? I would posit that it’s the renter who saves $7,200 each year by choosing not to own. A yearly savings of $7,200, wisely invested, will make for a nice little down payment when home prices finally move back into line with rents. (Remember down payments? Yeah, they’ll be back eventually.)”

“What arguments of this type fail to take into account is that homebuyers are themselves renters, it’s just that instead of renting homes, they are renting money from the bank. And when homes cost so much that the ‘rent’ on the money required to purchase a home, otherwise known as the mortgage interest, is more than the rent required to simply live in that same home, aphorisms like these cease to apply.”

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Comment by bubble_contagion
2006-05-26 10:18:19

Even if you have the $535K in cash it makes no sense to buy. If you put the money in the bank with a montly interest of 5%, it will pay you more than the $1900 rent.

Comment by deflation guy
2006-05-26 11:31:38

5% return on a virtually risk free 5 year government bond, or a 5% return on a piece of property that you have to manage (with all the hassles that go along with that). Which do you think has the most risk of capital loss? Not a difficult choice.

Comment by Surffroggy
2006-05-26 22:56:08

I really like the way that this article was worded. It sums up the whole manic state of the housing market very well. Price crashes have finally begun. I am so happy. The price declines should really pick-up speed now as news stories are all over about San Diego, San Bernardino median price drops. I thought Phoenix would be the first to start crashing but San Bernardino, CA dropped $10K from March to April according to ………and it is about time….YEEPEEEEE

Comment by david cee
2006-05-27 06:07:42

Risk free at 5%!!! .what do you think the price of gasaloine will be in 5 years. Your tank of gas will eat up any interest you receive and even some principle at the end of 5 years. Keep your save and liquid, the interest rate means nothing compared
to safety and liqudity.

Comment by LA_Landlord
2006-05-26 14:40:46

Depends on the rental market: after living in my current home for about five years (purchased with 20% down), my PITI is lower than what the house would rent for. I also took advantage of dips in interest rates to refinance and lower my payments (whereas a renter cannot do this, and in fact is usually worse off when rates decline if they had the money “in the bank” as you suggest). With cap rate compression, the value has increased well ahead of rental rates, too. I would be waaaaaaaay behind if I had rented the house five years ago.

Comment by Sunsetbeachguy
2006-05-26 14:51:53

Yeah, nice argument.

Go invent a time machine, travel back 5 years, load up on RE and get rich. This is a common RE bull refrain.

This is 2006 not 2000.

Comment by LA_Landlord
2006-05-26 14:56:17

Your argument doesn’t negate the fact that rents rise over time, which isn’t accounted for in his post.

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Comment by Randy
2006-05-26 15:08:41

Renting certainly helps, esp when one loses one’s job, and then has to move to find something comparable.

This is the new economy where being mobile is the key to maintaining a career.

Comment by deflation guy
2006-05-26 17:15:45

I’m in the Seattle area. Rents here have barely budged in the last 5 years. I could probably get $1,200/month in net operating income if I were to rent my home. If I decided to sell I could probably get about $400k for it. That’s a cap rate of 3.6%. It would cost the new owner almost $3,000/month for PITI assuming 3% down on a 30 year fixed at 6.5%.

I don’t see wages going up much around here. Furthermore, there is no shortage of rental properties available on the market. How can rents rise unless one of these factors drastically change? Let’s just say they do rise. Will it be a 100% increase in rents to bring the market back to equalibrium? I doubt it. The only variant that leaves for an adjustment is price. I really don’t think they are sustainable.

Comment by The Machinist
2006-05-26 17:59:27

I live in the Bay Area, and rents have been flat for the past five years. In fact, I negotiated my rate from $1300/mo. down to $1100/mo. a few months after the tech bubble popped. If the landlord had said “no” there’s a good likelihood I would have moved. It goes each way.

Comment by BillB
2006-05-26 18:27:53

I’m a landlord in the Bay Area, and from what I’ve seen, rents have dropped from 30% (Oakland) to 20% (San Francisco/Berkeley) during the 2001-2005 time period. Rents have just started coming back up in SF, but are still down in Oakland/Berkeley.

Comment by Rental Watch
2006-05-27 10:51:32

Actually deflation guy, the Cap Rate on your house would be well less than 3.6%. Cap Rates are measured on NOI, so rents less all operating expenses (Insurance, Taxes, Maintenance, etc.)–excluding of course mortgage interest.

The bet is entirely on appreciation today–rents don’t justify an investment.

Comment by Paul Cooper
2006-05-26 15:59:53

Who gives a sh*t about 5 years ago. 5 years ago RE prices were also half what they are now. Get a freaking clue. We are talking about buying or renting in 2006, not 2001. And it makes absolutely no sense to buy now at the peak of this bubble. My money is generating 3x the rent that I’m paying on this house vs what would cost to outright buy it. Anyone who’s buying a home right now is a complete idiot.

Comment by foobeca
2006-05-26 17:02:27

You’re ignoring opportunity costs. It really doesn’t matter what you paid for it. What matters is the price TODAY and how that compares to what it would rent for.

Let’s say you bought the house for $1 back in 2000 and it is worth $500k today. You can rent it for $1000/mo. You’d be better off selling the house for $500k to an “investor” and earn $2100/mo in interest. You could then rent the house from the “investor” for $1000/mo.

Comment by Surffroggy
2006-05-26 23:01:07

We are not talking about five years ago. Some of us, including myself, were still in college 5 years ago. Now prices are dropping: Did you sell before the crash? It is starting now, price drops and all…
,,,thank you

Comment by jbunniii
2006-05-26 23:26:06

Last time I checked, Los Angeles still has rent stabilization. Your rent won’t increase arbitrarily as long as you stay put.

2006-06-01 15:40:57

In Santa Monica there are loopholes that allow residential rental business owners to change the rent to what ever they want, without regard to length of tenancy, etc.

Those loopholes includes owner occupied triplexes and duplexes, and possibly 4 plexes.

A realtor I know owns a triplex and lives in one of the units. the realtor told me they don’t like one of their tenants they would triple thier rent, to make them move out.

And by making them move on their own free will, the tenant would be un eligible to any moving relocation money which is mandated in California to any tenant that lives in a rental for a year or more.

I suppose that the City of Los Angeles has a similar law governing owner occupied triplexes and duplexes

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Comment by Neil
2006-05-26 10:20:46

“Remember down payments? Yea, they’ll be back eventually.”

What I don’t understand is why PMI rates haven’t shot through the roof yet. I would be the last person wanting to hold onto that insurance. I posted before how down payment requirements will shoot through the roof.

Also, what happens if lenders go back to the old lending rules? Remember when to qualify for a 35% of income loan a 20%+ down payment was required? That was only 5 years ago. I bet within 18 months we’ll be back at old lending laws. Gee… what does that do for the market?

Sellers… enjoy the summer. Its your last chance to avoid the cliff. Yes, I know 75% of you don’t have to sell. Yea for you. But I’ll be looking at the actual transactions that occur. :)

Note: I’ve seen better renting deals on homes near the beach down here in the south bay. :)


Comment by Sunsetbeachguy
2006-05-26 11:52:56

PMI isn’t that important anymore.

Most borrowers avoid PMI through piggyback loans.

80/20 the 20 being a simultaneous HELOC or 2nd.

Comment by David
2006-05-26 12:26:36

“Note: I’ve seen better renting deals on homes near the beach down here in the south bay.”

Likewise in San Clemente. Buying the place my family and I rent (and it is for sale), would be FOUR TIMES our current rent. A block from the beach, and very accessible for a family like mine via renting, but out of our league for purchase. So what’s the difference to me? If prices go sky high and rent does not, then the prices are gonna collapse sooner or later (p.s. our landlord can’t find a buyer to save his soul)

Comment by Sunsetbeachguy
2006-05-26 13:55:12

Downtown HB is the same thing.

I have 6 spec homes rotting on the market within 2 blocks of me.

I am 4 blocks from the pier.

I rent for 29% of the cost to purchase.

Comment by Oscar de low Renta
2006-05-26 10:28:21

These two pieces are like a Cliff’s Notes of everything that’s been said on this blog, for the past 18 months, about renting vs owning.

I’m renting and socking away $750 a month in savings/investment. I figure if I can save up $25K over the next several years as condo prices fall and then flatten, I can finally enter the market in the year 2010 or so. With a responsible loan made on “old-school” lending terms (you know the old rules and ratios will all come back hard, after things melt down). And on a modest income.

Comment by Sunsetbeachguy
2006-05-26 11:54:10

Yeah, but there are lots of people out there who haven’t heard of it.

Like this dumba$$

See the 26th post.

Comment by Mikhail
2006-05-26 10:31:32

The comparison of costs from renting vs buying are all very interesting. However, what this fails to take into account is home appreciation. If one assumes perpetual home price appreciation, a renter will continually fall farther and farther behind, whereas the property “owner” will find their equity is building (even if they have neg am loan), since the market value of the house keeps rising 15% or 30% a year.

I am not saying it is wise to assume such perpetual market price increases, but the acquaintances I know who are into real-estate investing view this appreciation as the primary justification for buying. If one holds this view (i.e. that property prices will keep rising indefinitely), then it is easy to brush aside any concerns of whether rents pay for the mortgage/upkeep, etc.

Comment by waaahoo
2006-05-26 10:40:31

Mikhail, If your friends really do assume that real estate will appreciate at those rates you should sit them down and do a little math. At 20% a 200k house would be worth almost 3 times that amount in only 5 years.

Unless inflation and wages appreciate at the same clip it’s just not going to happen.

Comment by Bob the Banker
2006-05-26 10:42:14

Actually I think Toscano directly addresses this point:

“Of course, when used in the manner above, the word “equity” does not refer to wealth that is saved by avoiding excessive carrying costs. It refers to wealth gained by owning a home that is increasing in price. That’s a great plan, as long as homes are actually increasing in price — but they are not, nor should they be expected to for years to come.

People who bought homes five years ago ended up gaining a tremendous amount of money through price appreciation, but that train has left the station.
This isn’t 2001, it’s 2006 — and from a purely financial perspective, renters here in 2006 are making out like bandits.”

Comment by pinch-a-penny
2006-05-26 10:43:35

Keep in mind though that as prices appreciate indefinitively, Salaries have failed to keep up with that appreciation, therefore, the disconnect begins. Also remember that except in a couple of states, Taxes are directly related to that price increase. If your rental property has tenants (a rarity these days, those pesky tenants who actually pay the rent) then you will be losing ground every year, as you will be unable to raise the rent and keep the tenants. It has gotten to the point where I am paying my landlords taxes only!. I would end up paying far more if I had bought, in upkeep and maintenance.
The flip side to indefinite appreciation is that somewhere down the line will have to buy your property to realize the appreciation. Until then it is only a number on a napkin. If no one buys your property, or you only get low-ball numbers, then that is what the property is worth regardless of any perceived “appreciation”. The property is only worth what someone is willing to pay for it. If you are the buyer, then you must make sure that you also will be able to sell it without getting your shirt handed to you!

Comment by waaahoo
2006-05-26 11:00:54

That’s the boat I’m in. I’m paying the landlord’s taxes - and not all of them - for a 3bdr a half block from the beach.

Comment by NoVa Sideliner
2006-05-26 10:46:34

Indeed, and that’s why it’s a bit worrisome. Apparently, people haven’t lived through (or have forgotten) the long periods where housing in some markets has been stagnant with little or no appreciation. Too many people incorporate the appreciation into their calculations (if they ven do ANY!) as a given. It is, however, not a given after any significant run-up in prices like some parts of the country have seen.

In the long run, agreed, the base price of the real estate does increase. In the very long run. Then again, as the famous economist once said, in the long run we’re all dead. (Meaning we should also consider the short- and medium-run.) How long are people able to feed a money-munching rental that they need to subsidise every month? How close are you to retirement? Can you feed that rental for 10 more years? You might need to.

For those who know that they can wait a decade or more, they are *probably* fine, assuming also that they’ve properly taken into account the maintenance costs of holding the property, which many peopel do not. Key item: They expect property to appreciate x% per year but base their calcs on property tax staying fairly flat! Big d’oh! But that doesn’t mean that by buying (or holding) now means that they will be in a better position than buying three years from now. That’s guessing the market, of course, but it’s entirely possible that by 2009 they will be able to buy three houses for what two cost now.

Comment by Rental Watch
2006-05-27 10:56:47

In the height of the dot-com bubble, someone asked my why they should do anything other than invest in tech since it was going to be going up 30% per year.

Housing are not tech stocks, but an increase in housing at current rates is as unsustainable as the tech stock boom.

Comment by Bubble Butt
2006-05-26 11:04:25

Hmmm, “what this takes into account is price appreciation”. “If one assumes perpetual prices appreciation”…..

Yeah, back in 2000 I know people who thought the same thing with dotcom stocks they owned were going to continue to go up 50% per year for the next decade and dividend paying stocks were total losers, and company cash flow didnt matter.

They said it was the New Economy way of thinking.

In early 2000, my aunt stated to me that if she had another year like she did in 1999, she was going to retire. Funny thing by mid 2001 the value of her account dropped by 70%.

The similarities with housing and the dotcoms sound so eerily alike it is almost surreal.

Comment by Betamax
2006-05-26 11:07:45

Your acquainances are confusing trends with fundamentals, a typical error of naive investors.

Comment by skipintro
2006-05-26 11:27:58

But the appreciation doesn’t have to be all that dramatic to make owning a better deal, given a reasonably long holding period. Even with average appreciation of only, say, 5% a year over a 10-year holding period, owning is probably a better deal than renting. And with an amortizing loan, there’s also some equity buildup, since the principal on the loan is being paid down, albeit slowly.

What makes things so tricky now, especially in bubble areas like here in Cali, is that the recent runup has been so dramatic in comparison to trend, that it seems almost axiomatic that prices should decrease, not increase, for a number of years, which would seem to make renting the better deal. But who knows? Prices in Cali, over the past 50 years, have never suffered prolonged periods of value decline (say greater than 5 years).

Comment by climber
2006-05-26 11:52:25

Property actually doesn’t appreciate nearly as much as you think. Most of it is really the depreciation of the dollar. If you want to make good measurements you don’t use an elastic ruler.

The biggest benefit to borrowing money to buy a house is when interest rates are low, then you’re basically using inflation to cheat the lender. It’s a pretty good bet, but occasionally it backfires.

Comment by in_the_biz
2006-05-26 12:39:54

actually, would probably be better to buy a house when interest rates are high (and required return on investment is high, and asset prices are more rational) and then refinance when rates are low.

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Comment by SeattleMoose
2006-05-26 12:58:05


Comment by robin
2006-05-26 16:55:31

And if you lock in a fixed, you are guaranteed that your mortgage will never increase. Your property taxes and insurance and maintenance costs, however…..

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Comment by seattle slacker
2006-05-26 11:58:14

Robert Schiller claims that appreciation rates average 0.4% per year from 1898-2006. This includes the post WWII housing boom, and the present one as well. To assume 5% appreciation over a 10 year period is overly optimistic.

Folks, we are at the end of a serious boom cycle. Markets are cyclical. Buy or sell at the right time-the game is all about timing.

2006-06-01 16:06:35

I would like to add that in my research of real estate prices throughout the USA from the Mid 1920’s through the mid 1930’s, there was a price drop of about 70% and it pretty much stayed that way up untill 1933 and then there was a gradual increase over the next few years.

And from my calculations, it appears that the peak real estate prices from around 1927 did not get reached untill about 1940 or so.

I welcome any comments, additional info, or any info to the contrary.

Los Angeles Friends In Deed

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Comment by Chip
2006-05-26 14:45:59

“Prices in Cali, over the past 50 years, have never suffered prolonged periods of value decline (say greater than 5 years).”

5 years is OK with me — I’m not greedy.

Comment by lizziebeth
2006-05-26 11:32:34

Hello!!!! Anyone home???????????? Prices can not continue to grow at the rate they are. Your real estate investor friends may have been right back in 2002, but that theory no longer holds true! The statistics on inventory as well as rental properties speak for themselves. We have investment properties and we make $500 a month over our expenses. This is on properties that were purchased in 2000 and 2002. We are having to do some paint and new carpet on these properties as well as some ac repairs…… We use our rentals for the tax writeoffs on the depreciation… The average person doesn’t make the kind of income that justifies them needing the tax write off……… It’s true, you can either rent from the landlord or the bank. You can walk away if the realestate market continues to tank if you rent from a landlord. Or you can wind up owing more money than your house is worth if you rent from the bank. For us, we are in a financial position to pay off our rental properties and main residence if things get really bad. This comes from years of saving and hard work. It makes me sick to think of uneducated schmucks living the high life and gambling on the real estate market at the expense of young, naive, hardworking people! Go back to Vegas all you so called real estate investors!

Comment by garcap
2006-05-26 11:59:38


What about depreciation?

Comment by Sunsetbeachguy
2006-05-26 12:00:07

See Thornberg’s latest video:

People track recent trends not fundamentals.

Reliance on the last 3-5 years trends is what leads to booms/busts or as HARM would but it, ass-pounding.

Comment by Mr Fester
2006-05-26 21:07:35


I think you are right. Until I began looking more closely at it and especially playing around with the number,I simply thought the 10-15% appreciation trend was expected. Rather it is a bizarre blip.

Running the numbers is illustrative. Assuming 10,20, or 30% appreciation on a 100k home and 5% increase in salary over 10 years yields some interesting numbers:

10% Annual Appreciation
Home Income Home/Income
1.0 100000 50000 2.0
2.0 110000 52500 2.1
3.0 121000 55125 2.2
4.0 133100 57881 2.3
5.0 146410 60775 2.4
6.0 161051 63814 2.5
7.0 177156 67005 2.6
8.0 194872 70355 2.8
9.0 214359 73873 2.9
10.0 235795 77566 3.0

20% Annual Appreciation
Home Income Home/Income
1.0 100000 50000 2.0
2.0 120000 52500 2.3
3.0 144000 55125 2.6
4.0 172800 57881 3.0
5.0 207360 60775 3.4
6.0 248832 63814 3.9
7.0 298598 67005 4.5
8.0 358318 70355 5.1
9.0 429982 73873 5.8
10.0 515978 77566 6.7

30% Annual Appreciation
Home Income Home/Income
1.0 100000 50000 2.0
2.0 130000 52500 2.5
3.0 169000 55125 3.1
4.0 219700 57881 3.8
5.0 285610 60775 4.7
6.0 371293 63814 5.8
7.0 482681 67005 7.2
8.0 627485 70355 8.9
9.0 815731 73873 11.0
10.0 1060450 77566 13.7

Affordability plummets rapidly in all scenarios, so the party cannot go on for more than a few years.

Comment by deflation guy
2006-05-26 12:08:38

RE appreciation, in normal times, keeps up with inflation. What we saw the last 3 or 4 years was an anomaly. The cause of it was E-Z financing spawned by the global carry trade. The only reason this happened is because the FRB panicked and went negative on real rates when the last recession hit. The carry trade is over now that the yield curve has flattened. IMO the hedge funds will be crossing their fingers and hoping that the sub-prime loans don’t result in mass defaults. I think they will. IMO this house of cards is ready to succumb to “an event” any day now.

It’s time to “stock up the cellar”. When this disastor strikes we are all going to be in a world of hurt.

Comment by robin
2006-05-26 21:46:12

Canned tuna in water. 50 cents each on sale. Screw the mercury!

Comment by Sensible Lender
2006-05-26 12:36:44

Mikail’s comment:”property “owner” will find their equity is building (even if they have neg am loan), since the market value of the house keeps rising 15% or 30% a year.”

My house in coastal Los Angeles county, purchased in 1979. I have detailed value information in my neighborhood since the middle 80s. I have also been an appraiser and knowledgeable about RE.
I calculated the compounded annual appreciation to the following years, compared to my purchase price in 1979. I took value in each of these years and subtracted sales expenses of 6% at end date (however, I did not add cost of new roof, plumbing, painting, patio, remodel baths, kitchen, which would bring down the appreciation numbers:
From 1979 to
1990 10.4% per year
1996 4.7% per year
2001 5.6% per year
2006 7.1% per year

As you can see, the big increases in the late 80s were great, but the price drops in the 90s brought it way down. If prices remain level through 2010, my annual will be 6.2%.

Comment by Mr Fester
2006-05-26 14:15:20

Sensible seller,

To respond to your LA example. You do a nice job of illustrating the fuctuations in long-term trends. However, I would add another consideration. Since the 1970s, the West Coast has become increasingly expensive at the same time that the quality of life has declined. I would never even consider paying $500k or more to live in LA or the Bay Area, or to commute in daily traffic from the burbs. LA must have been a dream in the 1940s and 50s, but no longer. California as a whole is a beautiful place with a lot to do and see, but it is simply not so great that anyone would pay two to three times the going price for living elsewhere. The tide of immigrants to California is reversing and with good reason. I think it will always do that when we seen sustained run ups in home prices that create absurd market conditions in certain regions. The entire state is simply not worth the money. I see a slow lost of people and money for the next decade at least, or until the state returns to some form of sanity.

Comment by Sunsetbeachguy
2006-05-26 14:54:32

So does Nissan, they moved their Corp HQ to TN from Gardena.

BMW never bothered with So Cal and their automotive business is quite good.

Maybe Ford, Honda, Toyota, Hyundai, Yamaha, Kawasaki, Lexus and Daimler Chrylser will do the same. They all have NA HQ’s in So Cal.

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Comment by Mr Fester
2006-05-26 20:43:22

In a way, it might ultimately be good for California. It has gotten way to big way too fast. The source of most of the major problems is obviously too many people and too many operators who pray on the oblivious newcomers with stars in their eyes and a head full of air. If the boom is elsewhere, those husksters will follow it. I think…

Comment by LA_Landlord
2006-05-26 14:54:36

6.2% average appreciation is HUGE, given the leverage that can be achieved. With 20% down, a 6.2% appreciation is a 31% return, in ONE year.

Comment by foobeca
2006-05-26 17:15:03

If the mortgage has a interest rate of 6.200000001% with 6.20000000 appreciation, then the levarage does nothing for you. Keep in mind that the 6.2% figure quoted includes a runup in prices that is unprecedented in the history of mankind. Longer term appreciation in CA is about 5% or 0-2% after inflation.

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Comment by BubbleAnalyst
2006-05-26 12:52:57

Sure, I would buy if I foresaw 30% annual appreciation. I’m not seeing it though.

In terms of who is better off, a buyer or a renter, I will take whichever one is financially prudent and savvy. A fool (whether a buyer or a renter) and his money are easily parted.

Finally, I must be in a completely different universe from those willing to purchase a house with the idea that “longterm”–e.g,. 10 years–the house will appreciate. I have less than 30 years of prime income earning ahead of me. Locking myself into an investment and paying more than the asset is worth for 10 years (1/3 of that time) with the unsubstantiated hope that I will come out nominally ahead in 10 years would be a financial disaster.

Comment by LostAngels
2006-05-26 15:07:00

Your friends are not investors. They are speculators. If they are purchasing RE based on appreciation gains and not positive cash flow, this is called speculation. Speculating in RE after a huge runup is a dangerous game. Not much difference then 1999 and 2000 stock market…except this time it is different and RE never goes down and the city I live in ______ is insulated to any downturn because of XYZ reasons, etc.

Comment by moom
2006-05-26 17:38:08

The renter has to invest the money that would go to principal payments into another investment that also has signficant appreciation potential over time… actually in the long-term stocks probably appreciate more than residential property…

Comment by sfbayqt
2006-05-26 10:34:31

Yes, I know 75% of you don’t have to sell.

I’m sure that number is smaller than we think, and smaller than the sellers think, too. All most of them need is for *life* to throw them a curve ball (divorce, job move, illness, etc) and they will have to put the For Sale sign out whether they want to or not. It unnerves me the smuggness of people who think they are immune to happenstance. The absolute best we can all do is position ourselves so that we are not hit too hard if/when the curveball comes our way. Living beyond your means, no savings, debt choked is not the way.


Comment by Neil
2006-05-26 11:00:39

Good point.

One more detail to ponder.
The average American IIRC moves every 5 years.

on a $500k home, if we assume 6% commision at sales and 3% origination costs on the new house… we’re almost at a years median income per move! Or, 20% of our incomes will be consumed just in moving expenses.

And the more I think about it, how will real estate backed bonds sell in 2007 on without more PMI or downpayment to gaurantee them? Bond investors will eventually “wise up” and change this game if there are significant defaults. Or… they’ll just demand a return to justify the risk. Thus, why I predict required down payments will shoot up.


Comment by robin
2006-05-26 21:51:17

Didn’t the average American move every 3 to 4 years not long ago? Anyone have the data? It would be very interesting to see if there is a trend and a rationale.

Comment by Mr Fester
2006-05-26 13:55:27

Realtor Randy Friesen, whose truck bears the logo ‘If you’ve got money in the bank, you’re not buying enough real estate,’ hands out a phone book-sized package of properties he considers potential cash-flow generators.”

Bay QT, I think you need to talk to this guy about financial planning. No offense, but your fiscal model is so 90s. He is an insider and a Professional, so he probably knows more than we do. Yes, we definitely need to ….go to war in Iran!….er, HELOC ’til your satisfied!!

Comment by NoVa Sideliner
2006-05-26 10:36:11

Renting vs. owning. My pal with the the empty house he can’t sell (at his high price) thinks he’s found a renter. Hooray! And all the renter wants are a few upgrades (carpet, etc) that should cost no more than about three month’s rent. :-O

But the landlord is happy. The rent will cover his mortgage payment and even insurance as well. Maintenance? No worries about maintenance, “The house is only 15 years old, what can break?”

As for the opportunity cost of leaving more than $150k tied up in that stagnant real estate market, his words: “I know, I know, but I really don’t want to hear about opportunity cost.”

Well, at least he’ll be cash flow positive. Eventually. Sometimes. Maybe. (Yikes!)

Comment by sfbayqt
2006-05-26 11:08:07

NoVa, your friend is a fool. And tell him I said so. I bought a townhouse 7 years ago (it was 9 years old then) and the water heater just gave out…had to replace it. How much life is still left in the original appliances (washer, dryer, stove, refrigerator, microwave) is questionable, but I have a home warranty which helps TREMENDOUSLY. Another mishap….the tenants caused a fire 3 days before Christmas. MAJOR bummer…no one was hurt but there was damage( $10K worth). There goes my deductible (a small one, but still it came out of my pocket)…luckily the tenants have renters insurance.

My point: What could break/go wrong? One never knows. If your friend does not have a home warranty on his place, he’d better get one pronto…unless, of course, he is very liquid.


Comment by Arwen U.
2006-05-26 13:15:27

Since you’re talking N. VA - we searched and searched and bought a pristine (or so we thought) townhouse in Reston, VA in 1994. We had an inspection, the ropes. A month after moving in, the basement leaked badly. Ruined some stuff. We ended up paying 5K to fix the leak. This year, we sold and rented a brand-new SFH. A month later, the basement flooded. The builder thought it was smart to put the downspout pipe straight into the window well. Stuff happens.

Comment by redfish
2006-05-26 10:37:30

My dad sold a duplex in palm beach county that he had owned for 30 years to a gal he took a liking to, felt sorry for her so before the closing he prepared a spreadsheet showing she would have to raise rents by 100% just to break even. Figured that way he would have clean hands and could enjoy the proceeds better.

She bought it anyway.

Comment by Chicote
2006-05-26 10:59:01

It shows you that the victims of all this are not really victims, they are willing participants.

Comment by redfish
2006-05-26 11:07:13

Yeah when you’ve got a seller who was a local broker for 30 years showing you exactly why buying the property is a bad idea, and offering to let you out of the deal, and you go ahead and buy it anyway, you’ve got no room to complain.

Comment by Sunsetbeachguy
2006-05-26 12:07:23


that is an incredible story!

Denial ain’t just a river in Africa.

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Comment by hubrispie
2006-05-26 12:26:52

Speaking of this, I had a client several years back that bought the apartment which she had been renting. She was paying about $450 per month for it prior too purchase and at closing, the total expenses per month was about $1,000. I am sure that the new paint, carpeting, microwave, etc., was worth the extra $650 per month and the seller/developer also gave her $24,000 in “instant equity” on the deal because she was a former tenant.

Comment by feepness
2006-05-26 23:03:21

Numbers are hard.

Comment by Sunsetbeachguy
2006-05-26 10:42:02

Rich’s website seems to be down.

Hope it isn’t a DOS attack from the RE Industrial complex.

Comment by rich
2006-05-26 19:58:50

Hey Sunset - Actually I think it may have been a DOS attack. My site started using up huge CPU without having gotten a spike in visitors, so it’s either a DOS attack or a bug in the content mgmt software (though I haven’t changed anything with the system, so I suspect the former).

I’m holing myself up this weekend to upgrade all system software and make sure everything is bulletproof. It’s fun being hated! At least no disgruntled RE investors have come to my house to stab me yet… I think it will probably get a couple years before that happens.


Comment by Sunsetbeachguy
2006-05-27 14:57:55

Good work on your website.

Don’t let the bastards wear you down.

Do you get a huge volume of hatemail?

What is the most outrageous?

Comment by rich
2006-05-28 09:59:03

hey, sorry, i’ve been buried upgrading the site.

i don’t actually get that much hatemail. when i do, i’ve found the people always to be pretty incoherent. there’s a lot of ranting and poor grammar involved.

one jerk started signing me up for mailing lists, and i have another one who keeps sending me snippets from bullish RE articles… i have long since added him to my spam list but i still see him in my junk folder from time to time.

i wonder if ben get’s hatemail… fwiw i have gotten very little directly from; most of it comes from the articles.


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Comment by Sunsetbeachguy
2006-05-28 15:32:24

I finally registered at Piggington. So you have my e-mail now.

Comment by stanleyjohnson
2006-05-26 10:48:54

less than a week ago someone posted below site and total was around 800,000. now it is up to 810,000

Comment by orlandorenter2
2006-05-26 10:52:12

Do I hear 815,000? Yes I do check again.

Comment by Neil
2006-05-26 11:01:32

Do you know what the number was a year ago?

Comment by DC in LBV
2006-05-26 10:59:53

I love the last paragraph. I will have to incorporate that one into the financial education class I teach at church. I see so many in their 20s who are determined that they MUST own their own home by the time they are 30, no matter what it does to them financially. That lays it out so well, you can rent your house at this price, or rent the money to buy at this much higher price. Either way you are renting something. I try to tell them you don’t own it until the dead is in your name (just like cars), but that just falls on deft ears.

Comment by happy renter
2006-05-26 11:17:08

until the “dead” is in your name.
That’s kind of funny.

Comment by happy renter
2006-05-26 12:09:04

I guess I should add “Rest in peace FB’s”

Comment by John Law
2006-05-26 11:07:35

love the quote.

“I made my money by selling too early.”

Comment by deflation guy
2006-05-26 12:40:15

Me too - but I exited my PM and Energy positions way too early! Oh well, as they say, pigs get slaughtered…

Comment by Sunsetbeachguy
2006-05-26 13:58:21

I sold my energy fund a bit early. Must remember I am an early adopter.

Although selling early out of Enron was a masterful stroke and one tranche of my options was within a couple of points of the absolute top.

Comment by John Law
2006-05-26 11:13:37

the only thing dumber than buying real estate is putting money into stocks and bonds.

Comment by garcap
2006-05-26 12:28:08

I disagree, John. There are plenty of solid companies out there at reasonable prices. Not dirt cheap, but reasonable. I’d rather own stock in a company that has healthy, positive cash flow than stock in a house with negative cash flow….

Comment by John Law
2006-05-26 13:39:23

stocks are still historically overvalued. if you believe housing will fall hard, the IMF did a study and stocks fall even harder than real estate.

Comment by garcap
2006-05-26 14:21:39

i’ll take the other side of an IMF bet any day.

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Comment by deflation guy
2006-05-26 12:35:01

I think that government bonds are a good buy right now. Everybody expects inflation but I think the surprise is that we are heading into a classic deflationary liquidity trap. With a recession on the horizon, bond prices will probably rise. Besides, nobody likes them right now - that is almost reason enough to buy them!

Comment by Diggs
2006-05-26 13:50:54

“Besides, nobody likes them right now - that is almost reason enough to buy them!”

I don’t know much about government bonds but you are absolutely right about buying investments when nobody else thinks they are a good deal.

I had some AAPL stock I bought in 2000 right before the crash…DOH!!..afterwards when I was PO’d about it and everyone thought tech stocks were evil, I bought more. I doubt I have to tell you how that turned out. I sold enough to cover all my cost and will soon sell the rest.

Comment by mrincomestream
2006-05-26 13:38:07

If Enron is any indication of whats going on in the business community. I’d have to agree.

Comment by tom stone
2006-05-26 11:40:03

here in sonoma county home prices are still about three times their traditional valuation based on gmrm,or a 4xmedian income basis.we have an inventory that doubled in two months and lots of arms and i/o’s resetting,lots of drama on the way for the whine country…already getting ugly and just the start

Comment by M.B.A.
2006-05-26 11:46:31

Hmmmm…. what would Suzanne say about all this? After all, she is always right!!! ;)

Comment by ocrenter
2006-05-26 11:58:35

Rich’s example of his friend rings true.

Here’s another real live example.

Rental on a 1600 sqft home in a nice part of San Diego suburb is $2100/month, after the property management fee $1900/month. Home was purchased in 3/06 for $590,000 with zero down 100% financing. HOA roughly $150/month. Mello Roos at $200/month. property tax at $500/month. At $3000/month mortgage, the owner is down $2000/month!!

Now it turns out the owner is part of a group of friends that purchased 7 homes in the last 3-4 months for investment. at least 3 of these homes are of the same - $2000 cash flow monthly. There guys are now trying to dump these homes at $40,000 discount from their purchase price each. Only problem is that $590,000 home? Other homes in the same tract with the same floorplan are selling for $540,000 just 2-3 months after its purchase.

Comment by Sunsetbeachguy
2006-05-26 12:21:54

I was just going to post your example.

So here is mine.

I rent for 2k/mo.

The property is valued at $1.2M.

I rent for roughly 29% of the cost of owning.

Comment by garcap
2006-05-26 12:34:28

what is (are?) “Mello Roos”?

Comment by Sunsetbeachguy
2006-05-26 12:40:14

Mello-Roos are specific to California.

Named after the 2 state reps that allowed this end-run around Prop 13.

They essentially are local additional property taxes assessed to pay the incremental costs of that subdivision that base property taxes don’t cover.

Comment by garcap
2006-05-26 13:03:51


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Comment by S-Crow
2006-05-26 12:10:47

I know many of you vote for Pedro, but I’m voting for Rich Toscano.

Have a good and memorable weekend.

Comment by SoCalRenter
2006-05-26 12:31:27

The low cap rates in California are a direct result of Prop 13. For those who bought in 1978 (or inherited from parents who bought then) property taxes are out of the equation. So although the cap rate looks (and is) terrible for a first time buyer, it is not quite so bad for the trust fund baby. Of course, even when you subtract property taxes from the cap rate, California cap rates are still extraordinarily low.

Comment by JWM in SD
2006-05-26 12:53:29

That’s the because the asset prices/initial investment costs are too high relative to what people can afford to pay for rent (cash inflows). I’ve done a lot of NPV analysis in the manufacturing industry and the principles for investment and cashflow are the same. If payback takes too long and there are inherent risks, then initial investment is probably too high. At that point, alernative investment projects would be sought.

Comment by CA renter
2006-05-27 00:42:25

Exactly right, JWM! Prop 13 has nothing to do with it. The price distortion is due to the credit bubble alone.

Comment by Bigdaddy63
2006-05-26 13:37:39

Never underestimate the arrogance and greed of people. It’s all good and dandy until the music stops playing and you are the one left standing. Make NO mistake- this is the beginning- not the end of a huge unwinding of speculation. We are talking years, not months of reversal.

Something about a fool and his money?

Comment by M.B.A.
2006-05-27 04:25:20

yes - I don’t think we will see the “bottom” until 2008 or later….

Comment by peggus_
2006-05-26 16:21:20

I just signed the lease on a small 2+1.5 craftsman in Pasadena, it’s in a gorgeous historical neghbourhood filled with craftsman bungalows. It costs me $1800 a month to rent, I estimate I would have to pay $3500-$4000/month if I bought a similar house today.

The owners bought in 2003 for $350,000, they seem to be responsible people so presuming they put in a decent down payment and got a low interest rate, I am probably paying most of their carrying cost. They are moving since they have a third kid on the way.

I wouldn’t want to rent from a flipper as I fear they would try to raise the rent at first chance they got in order to alleviate their negative cash flow.

Speaking of flippers, a house down the street from the one I’m renting is for sale. It sold twice in 2005 and is now back on the market for $699,000. It’s a 2+1 craftsman but not as nice as the one we’re renting — according to my landlord who checked it out the first time it was up for sale.
Sale History
11/02/2005: $620,000
03/07/2005: $521,000

I’m going to enjoy watching from my rented porch as the last of the bagholders suffer.

Comment by Bill
2006-05-26 20:10:39

It’s been fun so far being a renter on the sidelines during this whole bubble. In 2001 I bought Series I bonds with its 30 year fixed 3% rate. I kept buying I bonds, municipal bonds, and added to my 401k, IRA, and non-tax deferred equities and last March (2005) started getting into gold. I was laughed at 2 years ago for “throwing my money away on rent.” I was laughed 18 months ago. Well a year ago the laughter stopped. My rent in scottsdale was $785 per month from August 2000 to June 2005 when I moved out. I’m now further south but rent is going up about 5% per year. at this rate it will be 15 years before rents catch up with mortgage payments on the current overpriced houses. No thanks, my investments are doing better. I love the freedom of renting. I have the last laugh.

Comment by CA renter
2006-05-27 00:44:26

Good for you, Bill! :)

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