Author Topic: Who would bother landlording in a HCOL area?  (Read 7383 times)

Ricky

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Who would bother landlording in a HCOL area?
« on: May 28, 2015, 02:21:00 AM »
In places like SF, LA, DC, and NYC where it's generally much cheaper to rent than to buy, why does anyone even own property all there? When it's cheaper to rent than to buy, you know the returns are much lower than in other parts of the country.

Are property owners there usually just too wealthy to care about returns, or are they banking on appreciation?

Obviously someone has to own the property, but I just can't imagine what type of person it would have to be? The only person I could think of would be someone who purchased before prices went crazy or inherited down the family line.
« Last Edit: May 28, 2015, 03:44:01 AM by Ricky »

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Re: Who would bother landlording in a HCOL area?
« Reply #1 on: May 28, 2015, 04:16:57 AM »
This is me, I guess.  I have a house in London that is worth 5 times what I bought it for 20 years ago as my main home.  I've been renting it out for the last 4 years, since I retired and moved to the country.  I've just heard that my current (very good) tenants will be leaving, so I need to work out whether to rent again or sell - I'm definitely leaning towards selling, as I'm pretty clear now that my retirement has "taken" and I that it's highly unlikely I'll ever be going back to live full-time in London again.

WerKater

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Re: Who would bother landlording in a HCOL area?
« Reply #2 on: May 28, 2015, 04:22:11 AM »
In places like SF, LA, DC, and NYC where it's generally much cheaper to rent than to buy, why does anyone even own property all there? When it's cheaper to rent than to buy, you know the returns are much lower than in other parts of the country.

Are property owners there usually just too wealthy to care about returns, or are they banking on appreciation?

Obviously someone has to own the property, but I just can't imagine what type of person it would have to be? The only person I could think of would be someone who purchased before prices went crazy or inherited down the family line.
I suppose that much of it is owned by people who have not done the math. Many of them would never invest in the stock market anyway because they find it too risky. Some might have bought at high prices, others might have bought a long time ago at more reasonable prices or inherited. I think that many of the latter people never go back to re-evaluate whether it is still good to own.

Of course, if you own your residence in such a place, and you are happy there and you love your house, then keeping it might be a reasonable decision. Even if it does not seem to make sense in the cold blooded financial analysis.

I do not know whether these work as explanations in the cities you mentioned, but I am pretty sure that it describes the situation well in many German cities where I compared owning and renting. If you ask real estate owners here what their Return on Investment is, they often have no clue what that even means. In their opinion "renting means throwing money away" and that's it.


Another Reader

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Re: Who would bother landlording in a HCOL area?
« Reply #3 on: May 28, 2015, 06:00:46 AM »
When it's cheaper to rent than to buy, you know the returns are much lower than in other parts of the country.

In real estate, your return comes from two sources, cash flow from rent and appreciation.  The most desirable HCOL locations appreciate more rapidly than do the low COL areas.  Rents generally increase more rapidly as well.  If you are fortunate or smart enough to pick up property in these areas when the real estate cycle is down, you can make a nice return on appreciation alone.  Leverage magnifies the return.


WerKater

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Re: Who would bother landlording in a HCOL area?
« Reply #4 on: May 28, 2015, 06:35:34 AM »
The most desirable HCOL locations appreciate more rapidly than do the low COL areas.
Source?

brooklynguy

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Re: Who would bother landlording in a HCOL area?
« Reply #5 on: May 28, 2015, 07:44:19 AM »
I suppose that much of it is owned by people who have not done the math. Many of them would never invest in the stock market anyway because they find it too risky. Some might have bought at high prices, others might have bought a long time ago at more reasonable prices or inherited. I think that many of the latter people never go back to re-evaluate whether it is still good to own.

Of course, if you own your residence in such a place, and you are happy there and you love your house, then keeping it might be a reasonable decision. Even if it does not seem to make sense in the cold blooded financial analysis.

I do not know whether these work as explanations in the cities you mentioned, but I am pretty sure that it describes the situation well in many German cities where I compared owning and renting. If you ask real estate owners here what their Return on Investment is, they often have no clue what that even means. In their opinion "renting means throwing money away" and that's it.

I think this is a large part of it, certainly among residential homeowners (and many "mom and pop" landlords).  If it all came down to cold blooded financial analysis by informed and rational market participants, then, absent other external forces that artificially inflate or depress market rates (for example, rent control regulations in NYC), situations should never exist where it is sustainably much cheaper to rent than to buy (or vice versa), because market forces would operate to establish an equilibrium.

Because local real estate markets can be highly inefficient, there are deals to be had even in expensive markets.  I bought my two-family row-house, which was not marketed well, for a good price (but still obscenely expensive by national standards).  In addition, I collect obscenely high rental income from its rental unit.  As a result, my housing expenses are lower than they would be for a comparable rental property.  However, it is true that I would probably be better off financially (but not by much) if I sold the house today -- every day that I decide not to sell is the economic equivalent of deciding to repurchase the house for its current market value minus transaction costs.  Yet I don't do so, primarily for the psychological and intangible benefits of keeping it.

The same logic extends to living in HCOL areas in general.  The OP could have asked why does anyone live in a HCOL area (unless they are being financially compensated correspondingly for doing so) when they can live more cheaply elsewhere?  The answer is the non-financial benefits to be had by doing so.

The Brooklyn I was born into in 1980--a place most people wanted to escape from--has morphed into a magnet that people the world over are now attracted to.  In retirement, I could capitalize on that and flee to another city which sits on the receiving end of the geographic arbitrage relationship.  Instead, I plan to stay put, partly because I am deeply in love with this city, and love makes you do crazy things.

My wife and I half-seriously joke that we hope our house stops rapidly appreciating, because, among other reasons, we don't want to reach the tipping point where we would decide to leave.

makeyourself

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Re: Who would bother landlording in a HCOL area?
« Reply #6 on: May 28, 2015, 08:03:18 AM »
My motherinlaw bought in London in the 80s, a house for 40k, payment of 100 pounds a month. She just sold for 1.2mm and retired. She only made 10k per year at her career peak.

This is common in London. I've met so many middle aged cabbies that have 4 bedroom detached houses. They cannot move into London at todays rates and their families can not afford to live in London anymore. The idea of retirement as a Londoner from years past comes with selling the home and relocation.

Here in NYC, most desirable rental properties and condos are bought up by investment firms as far as I am aware.



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Re: Who would bother landlording in a HCOL area?
« Reply #7 on: May 28, 2015, 08:06:09 AM »
I bought approximately one year ago in a HCOL area, Washington, DC. I purchased my house for $556k with $0 down on a VA loan. I recognize that this was a somewhat risky endeavor, but I took the plunge for a few reasons:

I saw big things happening in the area. A large building (Uline Arena) was in the process of being gutted to be retrofit as office space and retail (REI will put its East Coast flagship location there) a few blocks West, a huge mixed use development was going through zoning approvals a few  blocks North, and Whole Foods had entered an agreement to occupy the first few floors of a new building under construction a few blocks to the South, where a streetcar was under construction. There's also a 20-25 year, ~$7B expansion plan for Union Station, which is 1 mile to the SW, but will expand Northward. There's a lot more to discuss, but you get the idea...lots going on in the neighborhood.

DC is a strong rental market and probably always will be (knock on wood). My neighbor with an identical floor plan to mine and perhaps $10k worth of improvements over my house rents his for $3400/month. I rent one bedroom in my (3BR) house for $1200 to a friend and will probably seek at least $2900/mo for the house when I leave next year. DC has pretty strict rent escalation laws, allowing only CPI+2% increase per year. You can increase more than that if you make improvements or get new tenants.

Mortgage interest tax deduction and the ability to deduct cost of future trips to DC as a business expense (got to check on the property!) certainly don't hurt.

As others said, there's the dual benefit of appreciation and rental income. Also, HCOL areas have solid potential as vacation rentals. Another neighbor of mine rents his place on airbnb for something like $290/night..

I like to tinker with things in my house - do little projects here and there, and know that I'm building equity in my own pad. I know this is the case for a lot of homeowners...

Finally, and somewhat unique to my situation, I'll probably be back in DC a few times in the 12 years between now and retirement from the military. It's helpful to know I have a place to live each time I come back.


Poorman

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Re: Who would bother landlording in a HCOL area?
« Reply #8 on: May 28, 2015, 03:24:32 PM »
The most desirable HCOL locations appreciate more rapidly than do the low COL areas.
Source?

You can compare 20 different US cities on the S&P Case/Shiller website.

http://us.spindices.com/indices/real-estate/sp-case-shiller-20-city-composite-home-price-index

arebelspy

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Re: Who would bother landlording in a HCOL area?
« Reply #9 on: May 28, 2015, 03:34:24 PM »
The most desirable HCOL locations appreciate more rapidly than do the low COL areas.
Source?

You can compare 20 different US cities on the S&P Case/Shiller website.

http://us.spindices.com/indices/real-estate/sp-case-shiller-20-city-composite-home-price-index

Yes.  You can.  How does that provide proof for your claim?
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Poorman

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Re: Who would bother landlording in a HCOL area?
« Reply #10 on: May 28, 2015, 03:44:39 PM »
I bought my primary residence in a HCOL area in late-2010 because the monthly cost of ownership was the same as the cost of renting.  Now rents are higher and prices are much higher, even as interest rates have declined, and my monthly cost would have actually gone down had I refinanced into a 30 year mortgage.  Instead, I refinanced to a 20 year mortgage so the principal will amortize faster and the loan will be paid off sooner.  My wife and I have no plans to leave the area since family is close by, so buying a house made the most sense for us on every level.

Many people in Southern California don't think about the cost of renting vs. ownership at all.  They just want to get in on the appreciation gravy train or lock in a fixed cost for housing before it gets out of reach, even if the initial monthly cost is more than renting.

Buying for investment is best done by playing the market cycles and purchasing when there is "blood in the streets".  I remember looking at condos in 2011 that cash flowed $100-150 per door and have since appreciated $100,000 in value.  This situation comes along once every 10-12 years on average as too many people start speculating on appreciation, they get overextended, and then a good recession hits causing a wave of foreclosures.

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Re: Who would bother landlording in a HCOL area?
« Reply #11 on: May 28, 2015, 03:58:43 PM »
The most desirable HCOL locations appreciate more rapidly than do the low COL areas.
Source?

You can compare 20 different US cities on the S&P Case/Shiller website.

http://us.spindices.com/indices/real-estate/sp-case-shiller-20-city-composite-home-price-index

Yes.  You can.  How does that provide proof for your claim?

I didn't make any claims, Another Reader did.  However, if I wanted to validate his point, I would look at the change in the price index over a given period of time for maybe LA, San Francisco, or New York, and compare that to say, Las Vegas, Cleveland, or Detroit.


arebelspy

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Re: Who would bother landlording in a HCOL area?
« Reply #12 on: May 28, 2015, 04:03:27 PM »
I would look at the change in the price index over a given period of time for maybe LA, San Francisco, or New York, and compare that to say, Las Vegas, Cleveland, or Detroit.

Okay.  We'd need some data about COL also, and then have to run together the COL & Appreciation and see if there's a correlation between high COL & high appreciation and low COL and low appreciation.

I don't see that one link of Shiller home prices being enough for us to draw any meaningful conclusions.  But I might just not be thinking outside the box enough.  :)
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Re: Who would bother landlording in a HCOL area?
« Reply #13 on: May 28, 2015, 04:51:04 PM »
I don't bother looking up statistics.  I just look at the properties I own or have owned, properties my family and friends have owned or owned, and the areas where the properties are located.  My current house is at around 6-7 percent compounded appreciation since I bought it in 1989.  The Bay Area, Coastal Southern California, and New York have all far outpaced flyover country in appreciation.  Here in the Bay Area, since WWII, there has never been enough housing supply to keep up with demand.  And the folks with money all want to be here, or in the other highly desirable places.

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Re: Who would bother landlording in a HCOL area?
« Reply #14 on: May 28, 2015, 05:18:43 PM »
My wife and I were fortunate in the NYC real estate market.  In 1994, we bought our first apartment in Greenwich Village for 318K (with a 25% down payment).  Five years later, we sold it for double the price (635K) and bought an apartment in the Upper East Side for 740K (with 32% down), to be closer to our daughter's school.  Last year, we sold that apartment for 1.875 million. 

Considering the amount of leverage and appreciation, I believe we did way better than we would have had we invested that money in the stock market.  Having said that, I find it hard to recommend that young people buy an apartment in Manhattan at this point.  The prices are sky high, and there's no guarantee that appreciation will be as high.  My wife and I were lucky that the year we first bought (1994) was a relative low in the Manhattan real estate market.     

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Re: Who would bother landlording in a HCOL area?
« Reply #15 on: May 28, 2015, 05:26:21 PM »
There are a ton of investors that buy real estate for appreciation purposes only and most of the new investment purchases in these types of cities are just that.  In my opinion that is not a good way to invest in real estate.  Its a gamble.  They are buying in the hopes that it will continue appreciating.  You might as well go to vegas and hope you hit black at the roulette table.  haha okay maybe not to that extreme but you know what I mean.

I personally love investing in real estate and I will only buy if there is immediate cash flow from day 1.  Any appreciation is just icing on the cake.

waltworks

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Re: Who would bother landlording in a HCOL area?
« Reply #16 on: May 28, 2015, 09:35:24 PM »
People buy houses that are poor investments because people are bad with money. Just like they don't contribute to their 401ks or bring their lunch to work or walk 2 blocks instead of driving. No mystery, really.

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fishnfool

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Re: Who would bother landlording in a HCOL area?
« Reply #17 on: May 29, 2015, 05:12:36 PM »
Many places have a HCOL because of the lack of affordable housing in the first place.  Maybe they don't make sense if you're trying to stick with the 1% rule but some people value their HCOL investment as a future home for retirement. That is how we started out with our investment rental in a HCOL area. We bought it before the prices started climbing in the early 2000's but our rent was just paying the mortgage and other expenses, anything on top of that came out of our pocket. Not a great plan thinking back but now our rents have caught up and put us over the 1% rule.
With rents and property values rising I could not afford to pay the rent in the house we currently live in or buy it again if I had to. So not all investments make perfect sense when you first start out in a HCOL area. The housing bubble lost some air here in the bay area but it never really burst. Things are as crazy as ever!

Johnny Aloha

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Re: Who would bother landlording in a HCOL area?
« Reply #18 on: June 01, 2015, 04:10:16 AM »
Aside from the cash flow vs. appreciation discussion happening, there are other reasons to invest in HCOL area.  In my experience (and many other local owners I know), demand is so high that there is never a day of unplanned vacancy.  Tenants are very easy to work with and always pay on time.  3-8% annual rent increases are common due to the high demand.

WerKater

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Re: Who would bother landlording in a HCOL area?
« Reply #19 on: June 01, 2015, 05:12:12 AM »
Aside from the cash flow vs. appreciation discussion happening, there are other reasons to invest in HCOL area.  In my experience (and many other local owners I know), demand is so high that there is never a day of unplanned vacancy.
That is probably true. If the real estate market were efficient (which I think it is not) I would expect there to be a normal risk-return continuum:
LCOL -> higher risk -> higher returns (on average)
HCOL -> lower risk -> lower returns

I was actually meaning to look at the case-shiller data that was mentioned before to see whether this (or the opposite claim) holds true, but did not have time for it yet.

3-8% annual rent increases are common due to the high demand.
This sounds like a fallacy to me. True, demand is high in HCOL areas (that is why they are HCOL). But a steady high demand cannot explain significant increases (also, 3% nominal is probably little more than a zero real return). You would have to assume that demand rises all the time. That might be true but is not obvious.
On the other hand, if enough people agree with this logic, that alone will increase demand in HCOL areas because people figure real estate there to be a good investment. And then we have a self-fulfilling prophecy.

We also need to be careful what we look at. Obviously we can find many examples of cities that are HCOL today and that have shown good returns in the last years or decades and wen can find many LCOL areas with bad historical returns. But the causality is backwards: Because there was high (or low) real estate appreciation recently, these places have become HCOL (or LCOL) today. But the original high appreciation probably had an external reason. And it is not clear that the high (or low) appreciation will remain.
« Last Edit: June 01, 2015, 05:19:10 AM by WerKater »

Poorman

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Re: Who would bother landlording in a HCOL area?
« Reply #20 on: June 02, 2015, 04:09:14 PM »
3-8% annual rent increases are common due to the high demand.
This sounds like a fallacy to me. True, demand is high in HCOL areas (that is why they are HCOL). But a steady high demand cannot explain significant increases (also, 3% nominal is probably little more than a zero real return). You would have to assume that demand rises all the time. That might be true but is not obvious.
On the other hand, if enough people agree with this logic, that alone will increase demand in HCOL areas because people figure real estate there to be a good investment. And then we have a self-fulfilling prophecy.

You also have to take into account the limited supply of units coming online, minus those that are removed for whatever reason.  Most of the super expensive markets on the West Coast are either hemmed in geographically or have excessively burdensome building restrictions that make adding new units a long and expensive process.  So the demand may not be increasing by 3-8% per year but the geographic/political realities have contributed to a perpetual shortage of supply.

Johnny Aloha

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Re: Who would bother landlording in a HCOL area?
« Reply #21 on: June 03, 2015, 02:45:22 AM »

You also have to take into account the limited supply of units coming online, minus those that are removed for whatever reason.  Most of the super expensive markets on the West Coast are either hemmed in geographically or have excessively burdensome building restrictions that make adding new units a long and expensive process.  So the demand may not be increasing by 3-8% per year but the geographic/political realities have contributed to a perpetual shortage of supply.

Correct. 


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Re: Who would bother landlording in a HCOL area?
« Reply #22 on: June 03, 2015, 05:11:41 PM »
3-8% annual rent increases are common due to the high demand.
This sounds like a fallacy to me. True, demand is high in HCOL areas (that is why they are HCOL). But a steady high demand cannot explain significant increases (also, 3% nominal is probably little more than a zero real return). You would have to assume that demand rises all the time. That might be true but is not obvious.
On the other hand, if enough people agree with this logic, that alone will increase demand in HCOL areas because people figure real estate there to be a good investment. And then we have a self-fulfilling prophecy.

You also have to take into account the limited supply of units coming online, minus those that are removed for whatever reason.  Most of the super expensive markets on the West Coast are either hemmed in geographically or have excessively burdensome building restrictions that make adding new units a long and expensive process.  So the demand may not be increasing by 3-8% per year but the geographic/political realities have contributed to a perpetual shortage of supply.

True here in Oregon.  Check out our "UGB - Urban Growth Boundaries" which results in an artificial scarcity of land for building, as far as I can tell.  I think it's supposed to encourage the filling in of all of the land in the city center and attempt to preserve nature on the outskirts of town (and us Oregonians love our nature!).

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Re: Who would bother landlording in a HCOL area?
« Reply #23 on: June 03, 2015, 05:46:54 PM »
3-8% annual rent increases are common due to the high demand.
This sounds like a fallacy to me. True, demand is high in HCOL areas (that is why they are HCOL). But a steady high demand cannot explain significant increases (also, 3% nominal is probably little more than a zero real return). You would have to assume that demand rises all the time. That might be true but is not obvious.
On the other hand, if enough people agree with this logic, that alone will increase demand in HCOL areas because people figure real estate there to be a good investment. And then we have a self-fulfilling prophecy.

You also have to take into account the limited supply of units coming online, minus those that are removed for whatever reason.  Most of the super expensive markets on the West Coast are either hemmed in geographically or have excessively burdensome building restrictions that make adding new units a long and expensive process.  So the demand may not be increasing by 3-8% per year but the geographic/political realities have contributed to a perpetual shortage of supply.

True here in Oregon.  Check out our "UGB - Urban Growth Boundaries" which results in an artificial scarcity of land for building, as far as I can tell.  I think it's supposed to encourage the filling in of all of the land in the city center and attempt to preserve nature on the outskirts of town (and us Oregonians love our nature!).


Also there is the a proximity effect in many hot markets/HCOL areas like SF and Silicon Valley.  Demand for housing closest to the highest paying jobs is held in check by prices.  But it is highly desireable.  Areas further out are generally cheaper as you move further away but there is always some demand in intermediate areas as well.  It's the marginal places that have long commutes to these employment centers that have to worry about shifts in the economy.