re: Housing

June 16, 2021

Ben Felix

  • Can’t compare rent to mortgage payments
  • Can compare unrecoverable costs: a cost you pay w/ no associated residual value
    • Rent: the rent
    • Buy: not mortgage payment, property taxes, maintenance cost, and cost of capital
  • Property taxes ~ 1%; generally higher in states w/o income taxes (like 2%)
  • Maintenance costs ~ 1% of the home’s value
  • Cost of capital
    • Cost of debt: interest costs ~ 3% (add with pt, mc = 5% rule)
    • Cost of equity capital: you put down 20% on real estate instead of an alternative asset.
      • Globally real estate returned 1.3% from 1900 – 2017; stocks returned 5.2% after 1.7% inflation. So a nominal return of 3% for real estate; 6.9% for stocks. Round it to 3% cost of equity capital in real estate.
  • 5% rule: take value of the home you are considering, multiply by 5%, and divide by 12. If you can rent for less than that, renting is sensible.
    • $500,000K home would have $25,000 in unrecoverable costs or $2,083 per month
    • Can go the other way. Rental of $3k, multiply by 12, and divide by 5 is $720k. SO renting for 3K is financially equivalent to buying a $720k home.
  • 5% rule becomes 4% if you are holding a less aggressive stock portfolio, if you are taxed harshly on those investments, etc.
  • Housing best investment ever?
    • Real estate return = net rental income + price increase in the home
    • If you live in the house, you don’t get the rental income
    • So really, if you are living in the house, you already aren’t the subject of most claims about real estate’s great returns
    • 1870-2015 for GLOBAL housing 7.05% compared to 6.89% for stocks
      • but that means that you had to invest in housing in ALL countries
      • plus, housing, unlike stock, is not homogenous
      • and if you could buy housing across the world, you still have to manage all the properties
      • investing in any one asset is not a compensated risk. uncompensated risks can usually be diversified away by investing in a whole asset class, but that is hard with real estate.
    • If your monthly housing cost is higher than what you could rent it for, that loss will decline over time assuming your mortgage is fixed and there exists some level of rent inflation
    • Missing a single month of rent per year crushes returns
    • You basically have to be perfect to match the stock market
    • And if you buy in a single locality, you are in a similar situation to buying a single stock: the idiosyncrasies of the locality profoundly affect you
  • Why rent instead of buy?
    • Less risk: Short-term (<10 yrs) price fluctuations can crush a buyer who has to move. Not to mention the risk of taking on debt.
    • Predictable cost: maintenance costs for homes that can be random
    • No investment illusion: homeowners will spend heavily on a variety of things under the guise of increasing the price of the home even though there is no such guarantee that such efforts will pay off
      • Buildings can never go up in value. Ever. Period. Only land can go up in value.
  • Homeowners also pay “rent”
    • Renting services from the city in the form of property taxes
    • Unrecoverable maintenance costs just to keep their house inhabitable
    • Renting money from the bank while they have a mortgage
  • What about once the mortgage is paid off?
    • $500k home. Could sell and keep $475. Could invest that money at 6% while the long-term expected return on real estate is only 3%. That difference is op cost or $14k per year. Plus you still have maintenance and taxes post-mortgage.
  • People think their homes are better investments than they actually were. Big numbers. Failing to understand compound returns and the costs along the way.  Not to mention inflation.

The Wealthy Renter

  • All of the arguments against renting appeal to our inner consumer, who just wants to buy nice things
  • Easy reasons to rent
    • commitment-lite
    • no closing/selling costs
    • one fixed rent equals one fixed cost
    • no budget busters that capriciously appear
    • not owning means you don’t have the responsibility or risk
  • it’s easy to underestimate the cost of maintaining a home, particularly because the costs are infrequent and large
  • the amount of income you haven’t earned because you’ve owned your home instead of investing in other things is implicit rent
  • also implicit rent is the
  • buildings never go up in value; only land can go up in value
    • All properties have maintenance costs
    • For tax purposes, properties are depreciated – a fixed percentage of  a property’s purchase price can be ex[senses each year against the income the property generates
    • Properties in large cities tend to perform better than rural properties over time
  • Transportation has an almost magically quality that can alter the value of land
  • Lower interest rates put upward pressure on home prices, but not on rents
    • the lower the interest rate, the more money the homebuyer can pay for a home at the same monthly mortgage.
  • Speculation can drive up both house prices and rents; the downside risk is only really borne by homeowners
  • Population growth is a major driver of higher home prices
    • But it’s important to consider if this growth occurs in an area where there is plentiful land or not
      • There’s a lag to build, but if the land is there, price increases will be short-term before the supply adjusts to the population
      • “Las Vegas was prime example fo this kind of market in the 20000s, with essentially no limit on the amount of land available on which to build. As the broader US housing boom pucked up, LV boomed. As it did, lots of jobs were created, including jobs building houses. This drew even more people to Vegas for the jobs, driving even more demand for housing. As house prices rose, new house construction rose. THe temporary limitations of the housing industry to respond to the rising demand led to a rapid rate of growth in house prices, as builders struggled to find the materials and labor to build house fast enough to keep up with demand. Ultimatel, the housing market crashed, since there was no limit to the supply of housing. No matter how many people moved there, they could always build more housing. It just took a little longer than people were willing to wait. The run-up in house prices in LV violated the rule that only land can go up in value, not the building. The rapid growth in prices related to the building, not the land.
  • Leverage:
    • 300k home//30k down payment
    • 30,000 with 10 times leverage
    • Means change in the price of the home will have a 10x effect.
    • House appreciates to 303k. SO here equity is now worth 33k since the mortgage stays the same. a 1% increase in the underlying leads to a 10% increase for her. lower downpayment equals more leverage
    • Same thing in reverse. House goes to 297 and she is down all 3k, a 10% loss
  • Mortgage markets make housing more expensive
    • it’s easier to borrow and easier to borrow with higher leverage
    • housing prices are much cheaper in places where there aren’t mortgages
  • Bad investment
    • more than half of home sales occur in the spring – can’t get out whenever you want
    • non-fungible
    • transaction costs
    • can’t scale in
    • you look at buying a home as an investment and that clouds judgment
      • easy to lose track of the difference between housing needs and wants
      • Houses go up in value, so the more we spend, the bigger the gains
      • it’s an investment in our lifestyle, and it has the added benefit that it will go up in value
      • it can cost a lot to move, so if we spend more this time, we won’t have to move again, and we’re really saving money on  future move
      • this house is already “done,” so we won’t have to do any renovation, which always cost more than you expect and are a huge amount of work and a disruption to the everyday life
  • Home buying is an investment in land plus consumption fo the glamorous building that has been erected on that piece of land
  • in renting there is no investment creep, so renters have an easier time telling the difference between what they need and want
  • despite how clearly agents and lenders are incentivized to encourage people to buy and sell, these professionals are included int eh group most people look to for advice on housing
  • the simple fact that you’re locked in with a house purchase, that you’ve lost the option to leave, can affect how much you enjoy a new job (or if you pursue a new job)
  • owning a home going into retirement can put you in the awkward position of either over-comsuming housing or facing the significant cost of selling a home
  • We have to remember that, whether you’re a homeowner without a mortgage, a homeowner with a mortgage or a renter, the cost of living in a home is the same. All that is different is who we pay the rent to.
  • the riskiest part of relying on a home as a retirement fund is the concentration of all of your wealth in a single asset