Author Topic: Is this solid logic?  (Read 2411 times)

somebody8198

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Is this solid logic?
« on: July 03, 2016, 08:31:11 PM »
Hello,

I have been thinking a lot about owning vs. renting lately. I'm a single man, early 30s, with a high and fairly stable income and no debt, no dependents. I can easily put a good chunk of my paychecks (60%) into investments but I'm still renting so a portion of my income (about 20%) is being spent on rent and thus is not invested. I have excellent credit and could afford a mortgage but may have to go closer to 30% of my income on the mortgage because of the cost of owning in my area. I have more than 20% to put down toward the purchase of a unit.

As I run the numbers and think about it I just don't understand how so many people can afford to buy.. I checked and my income is in the 96th percentile. And yet... It seems to me like everyone and their mother is buying a condo. With interest rates incredibly low and buyers not being required to put down even 10%, wouldn't this drive up the prices dramatically? It's effectively lowering the standards for issuing mortgages so that more people qualify.. but if everyone qualifies, then you have a seller's market, because there is a lot of cheap credit flooding the market.

So my reasoning from that realization is that it would be better for me to rent for now and invest my money elsewhere for the future. At some point, interest rates will have to increase and then there will be fewer people qualified to buy. With fewer qualified buyers, prices will drop. Mortgages will be more expensive and very few people will have the 20% down payment, so I would have more buying power even if mortgage rates are higher. Essentially I am invoking Warren Buffet's adage to avoid investments when everyone is clamoring to buy and only buy when it's a buyer's market.

Is this solid logic? Any reading you could recommend to convince me one way or the other?

Thanks

FINate

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Re: Is this solid logic?
« Reply #1 on: July 03, 2016, 08:59:45 PM »
It's a coherent vision of the future, but the real question is how predictive is it? Coherence alone is insufficient to predict the future, which never unfolds so neatly since there are almost always unforeseen events and circumstances.

Real estate markets are very localized so I don't have an opinion about the valuation of real estate in general. Will interest rates affect prices? Probably, but it's difficult to quantify since so much depends on local earnings and employment. If rates are increasing, that typically means employment is robust, which means people have more cash to spend on housing. Certain regions could experience localized job losses while overall interest rates increase, which can happen because monetary policy is targeted at the entire economy so localized problems get lost in the average. Again, real estate markets are driven mostly by local factors (jobs, pay, demand for the area, ...). 

Let me suggest that you are essentially speculating, but instead of buying with the expectation that prices will rise you are delaying purchase in the hopes prices will drop. I would frame the decision in a different way: Can you really afford real estate in your area? Are you willing to make the tradeoffs necessary, forgoing consumption now for an asset you will likely own for a long time? Are you ok with the limits this puts on relocation? Are you willing to hold onto a purchase for 10+ years through price fluctuations?

In short, why do you really want to purchase real estate? I would encourage you to stop thinking of a primary residence as an investment - it's a place to live. Buying makes sense if you want long term stability, if you want the freedom to remodel and make it the way you want it. It's a way to [mostly] lock in a cost of living in an area where you want to put down roots.

Metric Mouse

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Re: Is this solid logic?
« Reply #2 on: July 04, 2016, 12:26:04 AM »
Rent vs. buy calculator could help confirm your logic. Put the numbers in and see if you might be missing something.

http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html?_r=0

juggleandhope

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Re: Is this solid logic?
« Reply #3 on: July 04, 2016, 12:19:29 PM »
It's a coherent vision of the future, but the real question is how predictive is it? Coherence alone is insufficient to predict the future, which never unfolds so neatly since there are almost always unforeseen events and circumstances.

I wish someone had explained this well to me when I was younger.  I appreciate now the clear phrasing.

In terms of the original question - it's true that you don't want to buy if you expect an imminent devaluation.  The bursting of the housing bubble in 2007 was pretty visible in advance, do you feel that the next one is?  Otherwise, there's some speculation involved.  But I also couldn't really stand the idea of giving away 30+% of my wages to rich landlords.  The benefit of buying vs renting has been worth hundreds of K in my case, but of course, there's lots of local and historical variables and it's conceivable it would have not been beneficial, had some other variation occurred. 


FINate

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Re: Is this solid logic?
« Reply #4 on: July 04, 2016, 06:00:47 PM »
I wish someone had explained this well to me when I was younger.  I appreciate now the clear phrasing.

In terms of the original question - it's true that you don't want to buy if you expect an imminent devaluation.  The bursting of the housing bubble in 2007 was pretty visible in advance, do you feel that the next one is?  Otherwise, there's some speculation involved.  But I also couldn't really stand the idea of giving away 30+% of my wages to rich landlords.  The benefit of buying vs renting has been worth hundreds of K in my case, but of course, there's lots of local and historical variables and it's conceivable it would have not been beneficial, had some other variation occurred.

Hindsight is 20/20. Looking back on an event we tell ourselves "of course, it was obvious" but in reality it wasn't clear to most people in the moment. If it were really that clear the rational thing would have been to short the market - yet only a few people did this, and they made a ton of money. So if you're positive the market is highly overvalued, sure, don't buy. Even so, I still say that very few people are true experts in real estate markets, so you should plan to buy to hold for at least 10+ years. Pick a place you like where you want to put down roots and don't worry about price fluctuations.

Finally, being a landlord is not as profitable as most people assume. They also have a mortgage (or if not, they have substantial capital tied up in real estate that cannot yield a return elsewhere). And taxes. And maintenance and depreciation. Add it all up and landlords make an ok return, but it is not without risk and it is in line with other investments. You can try to time the market, and you may think you're smarter than everyone else out there in terms of when/where you buy, but at the end of the day owning real estate requires one to assume a certain amount of risk. It's something you have to accept and be comfortable with.

Lmoot

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Re: Is this solid logic?
« Reply #5 on: July 05, 2016, 05:13:33 AM »
 I will say that spring and summer are the sellers markets in my area and in most areas as well. I would use something like Zillow, which I know yes is not nearly accurate, but might help you gauge the values of the homes over the period of seasons,  or for more accuracy the sale of recent homes versus their value today. Another thing you can do is find an area you want to live and just stalk individual deals. People  are always selling for different reasons: there's foreclosures, short sales,  fire sales, meaning they need to unload the property quickly. And fixer uppers. There's also the possibility of buying a property with the intention of having a roommate for several years then refinance or recast the mortgage after you pay it down with Roomate income, then getting rid of roommates after reducing your mortgage payment.

But I will echo others that primary properties are rarely good investments, sometimes in high cost of living areas it can be an even worse investment. At least in the short term, which in real estate time is 10+ years

somebody8198

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Re: Is this solid logic?
« Reply #6 on: July 08, 2016, 06:41:34 PM »
I wish someone had explained this well to me when I was younger.  I appreciate now the clear phrasing.

In terms of the original question - it's true that you don't want to buy if you expect an imminent devaluation.  The bursting of the housing bubble in 2007 was pretty visible in advance, do you feel that the next one is?  Otherwise, there's some speculation involved.  But I also couldn't really stand the idea of giving away 30+% of my wages to rich landlords.  The benefit of buying vs renting has been worth hundreds of K in my case, but of course, there's lots of local and historical variables and it's conceivable it would have not been beneficial, had some other variation occurred.

Hindsight is 20/20. Looking back on an event we tell ourselves "of course, it was obvious" but in reality it wasn't clear to most people in the moment. If it were really that clear the rational thing would have been to short the market - yet only a few people did this, and they made a ton of money. So if you're positive the market is highly overvalued, sure, don't buy. Even so, I still say that very few people are true experts in real estate markets, so you should plan to buy to hold for at least 10+ years. Pick a place you like where you want to put down roots and don't worry about price fluctuations.

Finally, being a landlord is not as profitable as most people assume. They also have a mortgage (or if not, they have substantial capital tied up in real estate that cannot yield a return elsewhere). And taxes. And maintenance and depreciation. Add it all up and landlords make an ok return, but it is not without risk and it is in line with other investments. You can try to time the market, and you may think you're smarter than everyone else out there in terms of when/where you buy, but at the end of the day owning real estate requires one to assume a certain amount of risk. It's something you have to accept and be comfortable with.

Yes, I agree that it would be much smarter to buy a home that you LIKE in a place you plan to happily spend at least 10+ years. Then if the investment doesn't work out at least you have a place to live that you like and will be happy with for a significant part of your life! I think my problem now is that I do not really know where I want to live. I don't have much of a personal life and I don't need very much space, so renting a cheap apartment isn't a big hit to my quality of life. I have spent between 8 and 20% of income on rent over the last few years, so it isn't as if I have been unable to buy other valuable assets in the meantime.

I do worry that I am missing out on an affordable housing market, but the housing in my area (dense, high crime urban center) is not very affordable at all. A nice condo would cost me about $350k which works out to being about 35-40% of my income for the mortgage, taxes, fees, etc. and I likely would not even get a yard or even a parking space out of the deal. I have never like the condo/apartment life and wouldn't want to be locked into it indefinitely. It just seems like a bad deal to me when I can currently find roommates to cut my housing costs down to 6-7% while investing the extra income and living a very comfortable life. I think in the future I would buy a house (not a condo) in a less costly area.

SwordGuy

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Re: Is this solid logic?
« Reply #7 on: July 08, 2016, 11:12:10 PM »
Condos are typically terrible investments compared to single family homes.   They are the first to lose value in a recession and the last to recover.

If you want to invest in real estate, you buy something for that reason and that reason only.

Don't expect to buy a place you want to live in at retail prices and make money.  You probably won't.  Particularly in a high cost of living area and particularly where you have to pay extra fees to a condo or home owner association. 

If you want to get into rental property, get a copy of Gallinelli's book, https://www.amazon.com/Estate-Investor-Financial-Measures-Updated/dp/1259586189/ref=sr_1_1?ie=UTF8&qid=1468038510&sr=8-1&keywords=gallinelli+cash+flow
 Learn how to calculate the numbers and then evaluate a property for investment.

There are 4 ways to make money:

1) Cash flow.  That's the best (assuming it's positive).  It's rent minus all expenses (current and set-asides for future repairs, vacancies, etc.).   It's the best because you don't (often) have to fork out additional cash when something breaks.

2) Amortization.  If you buy a rental property with a mortgage, your renters will be paying your mortgage.   In effect, you are getting the property for the cost of the down payment and closing costs.   That also assumes that the value of the property stays the same or goes up.   If the value of the property goes down, the equity from the amortization process will be lost or reduced.   And, if you are on a 30 year mortgage, you'll have to wait a long time before you see this.

3) Appreciation.   The value of the property may go up over time.  This is bonus money.   But it has to go up at least 6% over inflation or you will give all that increase to the realtor when you sell.   And if you don't own it for several years, you may have higher taxes. (Not sure on the details as I don't intend to sell mine.)  Condos typically underperform in this category.

4) Depreciation.  This is a tax credit based on the value of the improvements on the land and (maybe) the interest on the mortgage.  It's nice to have but not a reason to buy a property, just a way to shelter a bit of income from the tax man.

I make my money currently with options cash flow and depreciation because I'm not planning on selling any time soon and they are the most dependable way to make money with rentals.  Amortization and appreciation only help me if I sell or cash out the equity in the property via a loan.  Appreciation is not in my control, so I don't count on it at all.  (Because I've been buying for cash, I'll only get use of amortization if I cash out with a loan.  I might choose to do that to acquire another property free and clear.)

I increase my net worth in addition to that because I buy homes that need work.  My wife and I do much of the work to keep the repair costs down.   Our purchase price plus the repair costs have been in the 55 to 65% of the after repair value (ARV) of the property.  That's appreciation you can count on and it's quick.  It doesn't take years to show up and it's not nearly as subject to the whims of the market.   

Example:  Comparable houses, but in good condition, are valued at $80,000.  I buy a house for $38,400 and put about $7,000 into it.   So, for about $45,400 I end up with a $80,000 house after about 10 weekends of work.  I rent for $765, which is 1.68% of the cost to market.  Conservatively, I should make about $4,800 after expenses and set asides for future repairs or vacancies. 

Second example, comparable houses, but in good condition, are valued at $80,000.   I buy for $37,000 and put $13,000 into it.  Sadly, that took 6 months worth of weekends because there was more damage than we expected.  (We had planned on $7,000 in repairs and 3 to 4 months.)  We rent it for $820, or  1.64% of the cost to market.   Next year I'll aim for $835, or 1.67% of cost to market.   2% of cost to market would be considered "the promised land". 

Example 3: We're working on our 3rd rental now, after a hiatus caused by my mother's illness and subsequent death, and moving to our new primary residence.  Purchase price $30,000.  Expected after repair value is $80,000.   We expected to put in $12,000 of work, but it's been a rough year, so we'll probably hire out more than we otherwise would.  So, let's say $15,000.
Rental price we're aiming for is $800, but we may have to go $750.    That puts us in the 1.67 to 1.78% of the cost to market.
Had we kept to the original $12,000 repair estimate, we would be at 1.79 to 1.9% of cost to market. 

It's possible to make money buying a property at retail price on a 30 year mortgage - provided the rental amount is high enough.   But it's a whole heck of a lot easier to do it when you're acquiring a rentable property for 50 to 62.5% of retail value...

So, if you are really serious, get the book I recommended and learn how to run the numbers.  You'll find a slew of other books that have good info on how to find properties and how to structure deals to make more money or put less money in.  Get them and read them, too. :)

Because I can assure you that if you think buying real estate for investment is anything at all like buying a house to live in, you simply do not know what you don't know.  It will blow your mind to learn it. :)

Best wishes and good luck with your endeavors.

FYI, my journal on this site talks about the fixing up process we've gone thru on our rentals, in case that might be of use to you.





NoNonsenseLandlord

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Re: Is this solid logic?
« Reply #8 on: July 11, 2016, 07:13:19 AM »
Skip all the rental vs owning calculators.  They do not factor in the most important factors that you will need to use.

Buy what you need, when you want, where you want.  That is the #1 factor in making a rental work.  Keep an uncluttered life.  Do not own lawnmowers, rakes, etc.

If you are going to rent a home, and stay there for many years, then buy.  If not, rent close to work, and get out of the rat race sooner.  Use your saved commute time to do an outside gig, or work more and get promoted.

http://www.nononsenselandlord.com/2014/10/rent-or-buy-a-home/

sequoia

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Re: Is this solid logic?
« Reply #9 on: July 13, 2016, 11:43:58 AM »


Example:  Comparable houses, but in good condition, are valued at $80,000.  I buy a house for $38,400 and put about $7,000 into it.   So, for about $45,400 I end up with a $80,000 house after about 10 weekends of work.  I rent for $765, which is 1.68% of the cost to market.  Conservatively, I should make about $4,800 after expenses and set asides for future repairs or vacancies. 

Second example, comparable houses, but in good condition, are valued at $80,000.   I buy for $37,000 and put $13,000 into it.  Sadly, that took 6 months worth of weekends because there was more damage than we expected.  (We had planned on $7,000 in repairs and 3 to 4 months.)  We rent it for $820, or  1.64% of the cost to market.   Next year I'll aim for $835, or 1.67% of cost to market.   2% of cost to market would be considered "the promised land". 

Example 3: We're working on our 3rd rental now, after a hiatus caused by my mother's illness and subsequent death, and moving to our new primary residence.  Purchase price $30,000.  Expected after repair value is $80,000.   We expected to put in $12,000 of work, but it's been a rough year, so we'll probably hire out more than we otherwise would.  So, let's say $15,000.
Rental price we're aiming for is $800, but we may have to go $750.    That puts us in the 1.67 to 1.78% of the cost to market.
Had we kept to the original $12,000 repair estimate, we would be at 1.79 to 1.9% of cost to market. 

FYI, my journal on this site talks about the fixing up process we've gone thru on our rentals, in case that might be of use to you.

We are trying to do the same thing right now. Appreciate you sharing this!