The Great Rent vs. Own Debate

Owning a home is not right for everyone. There are certain benefits to not owning the home you live in. If something goes wrong with the property, you simply ring up the landlord and they get to fix it. You pretty much know what your cost are going to be month to month (unless your landlord decides to sell the property, increase rent, convert the condo, etc.). On comments from last Friday’s post on interest rates, there is a discussion debating if one could consider having a mortgage as a forced savings plan. I know I’m going to seem biased since I am a Mortgage Planner…and I fully expect all of the number-crunching-junkies out there to have a heyday with what I’m about to post…but here goes!

[photopress:northgaterental.jpg,thumb,right]I found two similar homes, both in the north Seattle area. The rental property is available for $1850 per month. The home for sale, with close square footage, rooms, area, etc., is available (actually, an offer is pending) for $499,995.

With the comparison, I’m going to assume someone has 20% down to either invest in the stock market or to buy a home. The current rate for a 30 year fixed is 5.75% (APR 5.904%). Principle Principal and interest is $2,334 plus taxes and insurance equals a total payment of $2623. First year monthly tax benefits are $606 (mortgage interest benefit will decrease, property tax benefit will most likely increase).

The prospects are in the 28% tax bracket; they have a gross income of roughly $8000 per month and can have $700 in monthly debts with credit scores at 680 or better. The investor will receive 11% from the stock market and the homeowner will benefit from an appreciation of 7% on their real estate.


at 5 years


at 5 years

Total Payment $117,863 Total PITI $157,396
Principal Paid 0 Principal Paid $28,951
Tax Benefit 0 Tax Benefit $35,293
Net Cost


Net Cost


Real Estate Value 0 Real Estate Value $701,269
Loan Balance 0

Loan Balance

Total Home Equity


Total Home Equity



at 10 years


at 10 years

Total Payment $254,498 Total PITI $314,792
Principal Paid 0 Principal Paid $67,519
Tax Benefit 0 Tax Benefit $67,893
Net Cost:


Net Cost:


Real Estate Value 0 Real Estate Value $938,566
Loan Balance 0 Loan Balance $332,477
Total Home Equity


Total Home Equity




Opening Balance $109,000 Opening Balance 0
5 Yr Return @ 11% $188,452 5 Yr Return @11% 0
10 Yr Return @11% $325,817 10 Yr Return@11% 0
5 Year Net Worth


5 Year Net Worth


10 Year Net Worth


10 Year Net Worth


The first five years with the mortgage provide an average monthly principle reduction of $482.47 per month. Taking out any appreciation factors, the principle principal paid each month is a forced savings plan. With that said, home equity does not earn interest. And I would probably encourage most clients to consider not using the entire 20% for the down payment to stay more liquid (depending on their entire financial picture).

For many Americans who do not have a savings plan (and the statistics show that many do not save), owning a home is as good as it gets for building savings…and it ain’t so bad.

Let the games begin!

This entry was posted in General, Mortgage/Lending and tagged , , by Rhonda Porter. Bookmark the permalink.

About Rhonda Porter

Rhonda Porter is an NMLS Licensed Mortgage Originator MLO121324 for homes located in Washington state. Her blog, The Mortgage Porter, is nationally recognized for sharing relevant information to consumers about mortgages. She has been originating mortgages since 2000 at Mortgage Master Service Corporation #40445 Consumer NMLS Website: NMLS ID 40445. Equal Housing Opportunity. You can follow Rhonda on @mortgageporter, Facebook and/or Google+

194 thoughts on “The Great Rent vs. Own Debate

  1. First, I think 7% appreciation is a pipe dream after the last few years.

    But some other things are missing here.

    -What is happening to the $800/month that the renters don’t have to spend on home ownership each month? Are you assuming that money just gets spent? I would assume anyone savvy enough to have $100k stashed would know that they ought to at least fund a couple Roth IRAs with that money.

    -Where are the maintenance/improvement costs on the property? Homeowners pay those, renters don’t.

    -Where is the differential in utility costs? It’s rare that renters pay water/sewer/garbage costs.

    -Have you factored in the standard deduction when calculating tax benefits? Renters get to take that without paying any property tax or mortgage interest.

    Even without these considerations, ultimately, the notion of a mortgage as a “forced savings plan” boils down to whether you think the risk premium is worth tying up your assets. With CDs at 6%, I can’t see how going after that theoretical 1% yield is worth the downside risk.

    Houses do go down in value sometimes, you know.

  2. Sour Mash,

    With the total PITI of $2623, less the tax benefit of $606, the effective mortgage payment is $2017. This is a difference of $167 from the rent paid.

    Home owners do pay maintenance/improvements and depending on the what those maintenance/improvements, they often receive benefits in the form of appreciation on the property.

    I believe I was being generous with the 11% return on the down payment funds not used for home ownership.

    I’ll itemize any day itemize the $22,997 in mortgage interest and $2988 in property taxes…with the 28% tax bracket, that’s a benefit of $7275.80. Add the point (based on the 5.75% rate quoted) as a write off and your benefit is now $8395.52.

    But I would do this in order to own a home to call my own. And to reap the appreciation…which, in every home I’ve owned in the past 20 years (since I’ve been buying) I have received.

    As always, I recommend that people check with their CPAs regarding tax advice. Here’s a decent article from bank rate regarding mortgage interest and deductions:

    Hey…you know rent goes up, too!

    As I mentioned in the post, there are many ways to disect and look at these numbers…this is just one view.

  3. 7% is not a pipe dream in the NW, I disagree. Especially over a 5 year period.

    I like to think of it this way –

    20% down is silly 🙂 Get a lender that will remove PMI when your LTV hits 80%. Then in three years lobby to remove the (negligable) PMI.

    Spend $93K over five years for an ROI on that money of about 350%.

    Probably the biggest variable here not mentioned is the upgrades/improvements done to the house.

    Of course the market will flatten out, it has. Even with a 3% return on the initial asset, ROI for what would have been rent money still exceeds 100% in five years. A good stock market guru could double your money there every seven, not five, and that’s if the housing market stays at 3% for years. Unlikely.

    Great post.

  4. A couple things. Monthly rent is not a fixed cost. Unless you have a 15 year lease, it will continue to rise with the value of the property. In five years, the rent payment will likely exceed the mortgage payment.

    I bet the comparison favors the mortgage even more when you do 10% down instead. PMI is now tax deductable and higher LTV’s creat even more leverage in equity growth.

  5. You are all SERIOUSLY delusional (“drinking cool aid” term comes to mind ) if you think housing is going to appreciate 7% over the next 10 years or even over the next YEAR.

    House prices are FALLING now EVERYWHERE, including in the Pacific Northwest. Why are they falling? Where do I start: wages haven’t kept up, subprime sector will be destroyed in a month (yes this matters ever for prime borrowers as new buyers need to come from somewhere), lending standards are tightening, investors are disappearing, and, critically, psychology is rapidly shifting away from “housing will always go up” to something more like “i can just wait a few months and the price will be lower”. Real Estate now is entering classic financial death spiral much as in the previous 6 years it was in a classic bubble mania. THis 500K house is not going to 900K in 10 years, Its going to 350 in 3 years + then might crawl back up to something near 500k in a decade (i’m basing this on historical data from previously boom/busts in the pac nw, la and SF).

    My advice: don’t catch a falling knife and wait wait wait, this house, all houses are getting cheaper ever day.

    Do your research!!!! Google: “housing bubble”, go to Roubini’s or Ben Jones’s blog, or go to wikipedia on “housing bubble”, read all what you find, find/build a spreadsheet model of your house payments, and plug in various worst case assumptions on appreciation (= -5%, flat, etc) — you will see that now is NOT NOT NOT NOT NOT NOT NOT the time to buy.

  6. Todd and Luke,
    Thanks for your comments. I always lean towards keeping things on the simple side. We all know you can twist numbers anyway you want to. I probably would prefer the 10% down scenario too (depending on the buyers current assets).

  7. Rhonda,

    Your analysis is overly generous with regard to the cost of home ownership. As was pointed out above, you overestimate the tax benefit of ownership, completely ignore maintenance costs (often 1-2% of the purchase price of the home, per year), and apparently assume that the renter would not be investing the money they save every month.

    Historically, home ownership is usually (at best) a break-even financial proposition, when all costs are taken into account. I’m not saying people should never buy a home, but to buy a home with an expectation of financial gain is folly. Buy a home only as a place to live in, invest your money somewhere else.

  8. I think this analysis is good – and pretty standard. there are probably 20 web calculators out ther that will give you the same results. No questions on the methodology – but I think many will quibble with your assumptions of 7% for housing.

    Biggest issue is with housing. The long term nominal ROR on housing – at least before the housing boom that kicked off in the late 90’s – was about 3-4%. In real terms, it was about 0.5%. Don’t believe me, look it up. However, in the last 10 years, house prices have doubled/tripled – giving you a long term appreciation of 7% or so.

    The question is: which do you believe? Personally, I look at the factors that drive housing cost: population, cost to build, income, and cost of financing. Sesame street question here – Which of these has changed? um, yeah, financing! Easy credit goes away, I think the long term trend looks more like the 1890-1990 trend and less like the 1990-2007 trend

    Just my $0.02

  9. I looked over the numbers and yeah they are calculated properly, incl rent, tax, investing, etc. Of course who am I to say what’s right or wrong, right?

    Anyways my point is that if you factor everything together yeah the numbers make sense. Though I do want to point out that I have found the real return over the long haul on a house is about 4% and stock about 10%.

    And I think there is the crux of the discussion. If you say, but wait look at how the markets have developed for the past decade then I would say that is not an appropriate argument. Let’s say we happen to be looking at the decade from 1990 to 2000, and then compare 1995 to 2005. You would have two completely different set or returns. Let’s say you compare NASDAQ vs S&P for those two perios. With the NASDAQ you would still be crying, whereas with the S&P you would be semi happy.

    My point is that timing is everything and I wonder if we are not in 1999 right now.

  10. Me: My name is Michael. I am a number-crunching-junkie.
    Group: Hi Michael

    the calculation includes disounted cash flows and non discounted cash flows. All the cash flows need to be discounted to account for the time value of money. Just as the TVM is used to get from $499,950 to $701,269 five years later, TVM must be applied to all cash flows. Also, the discounted oppurtunity costs need to be accounted for.

    the disounted net costs of renting or buying are within a few thousand dollars of each other making it a toss up.

  11. Does the tax-free primary residence allowance have any impact on comparing these assets to each other?

  12. Timing is everything???

    But it’s ALWAYS a good TIME to buy….before you get priced out!!!!

  13. The following is my opinion;
    The high appreciation housing market has for at least the last ten years has been fueled by aggressive marketing by the finance industries with their low rates finance zero money down: refinance/cash-out programs. This has been furthered fueled by the so called finance and real estate experts who condoned the idea that the bigger the mortgage is the better off you are; because you can put that money in the stock market.( looks good on paper) .All that said, we sometimes fail to remember the consequences of a tremendous housing market namely the affect it has on the economy including the stock market. When you take all of the big picture, of how one effects the other into account instead of just looking at all the individual aspects, you may come to a dreadful conclusion that if one fails completely the others is on its way out too!. Frankly, I always like to have a place thats paid for to hang my hat!

  14. I’ll itemize any day itemize the $22,997 in mortgage interest and $2988 in property taxes…with the 28% tax bracket, that’s a benefit of $7275.80. Add the point (based on the 5.75% rate quoted) as a write off and your benefit is now $8395.52.

    Yes, but the standard deduction is around 11K for a couple. So you can’t count all of the $26K as a comparative benefit. The comparative benefit is $15K, which is a tax benefit of about $350/month. And this amount decreases over time.

    If protecting income from taxes is the goal, there are far better ways to do it than by borrowing money for real estate. Saving for retirement is a pretty good one. (Does our hypothetical couple, who would be paying 1/3 of their gross income on housing, have properly funded retirement savings plans?)

    And I agree that factoring in rent inflation, renter’s insurance, and some assumed moving costs should also be part of the picture if someone is really trying to do this analysis seriously.

    My comments were a reaction to the argument that a mortgage could be considered a forced savings plan. That just doesn’t sit right with me, especially in an environment where legislators are beating the drums to grant forbearance to people who borrowed over their heads.

    Saving is a savings plan. Not borrowing.

  15. For most of my clients, even those who put 20% down, their home is their savings plans. I wish more people, home owners and renters alike, had more savings. It’s just not happening these days. I loved how someone mentioned the the other day on a post at RCG that we’re suffering a Credit Bubble. I agree. It’s out of hand. My 14 year is receiving offers for preapproved credit cards…what’s next? My cat or dog?

    Welcome, Michael! Can I call you NCG (number crunching junkie) for short? 😉 So if I understand you correctly, you’re saying (bottom line) that it’s 6 one/half dozen the other as far as a financial benefit?

  16. First disclosure: Graduate hard science degrees, in credit for > 15 years, very very familiar (cough cough, involved, cough cough) with real estate financing on portfolio level, eg, not little calculators for a single loan (no offense) but on the level of portfolios including hedging strategies, vintages, run rates, correlations, transition matrices, CLOs,etc. Google ABX Index or stare at for a while to get a flavor of my experience

    re ? about when to buy, two rules of thumb: if you are an investor, look at the gross rents you can generate and multiple them by 120-150, eg, you get 2K a month in rent for a property, that property is worth 300K to you. THINK for a moment about the math, 2k a month = 24k a year = 24/300 equal a decent (but not stellar) 8% pretax return. Yes yes yes, you hope appreciation + there is leverage in your purchase but houses do go down as they are going down now and you have to deal with taxes, potentially dead beat tenants, broken dishwashers, etc.

    if you are are an owner, think 180 times what houses like that are renting for in the same area. Again, a house renting for 2k is worth 360k.

    Houses are NOT anywhere near these #s (did i mention that these rules of thumbs applied for MOST of the past post WWII era for houses?).

    Net net, until real estate reverts to these historical means, it is probably NOT a good time to buy. DO pay attention to the real estate carnage happening all around as you read this. DO enjoy living in a rental that would cost you 2-3x as much every month if you chose to buy that house. DO read what intelligent people “in the business” area saying (google roubini, google ivy zelman at credit suisse, read robert shiller) and, above all, be very very very careful with your money as many people have a vested interest to close real estate deals quickly.

  17. to michael the number geek, I am one too!! Links to Proc GLM, Proc LOGIT, and MatLAB are on your desktop, right?

    RE your TVM calcs, FAR more important are the model assumptions, forget discount rates. Concentrate on 7% YOY (year over year) appreciation over 10 years. My model geek friends would laugh you out of the nearest SUGI (“SAS User Group” to the masses) meeting if you stated this assumption right now. Doing a Time Series analysis of comparable sales with SAS/ETS (you do use SAS Econometric Time Series Software, right?) does NOT support any appreciation in ANY MSA (metropolitan statistical area) right now. Think “reversion to the historical mean” rate of real estate appreciation (3-4% a year) but ONLY after prices correct themselves very very very significantly (-20% is a figure being bandied around the geekie water coolers I hang out at)

  18. Finance Guy and Michael, OMGosh! I think I’m going to gracefully bow out of this conversation (in fact, I’m calling it a night…and beginning my birthday celebration). Cheers!

  19. Hi Rhonda,

    I have read a few academic papers on the rent vs buy scenario. It is a toss up in the long run. As you mentioned it is a forced savings account for most people. Many real estate professionals like to say more people have become wealthy from real estate than any other industry. They use that quote out of context. That saying is based on a study from the 70s. In the study retired folks had their house as their most valuable asset for retirement. It is very possible to rent and be better off in the long run. The tradition in America is to buy a home.


    You win the geek contest. I went to Seattle U for graduate school and spent almost ten years at Microsoft in financial operations. No I do not use SAS software. I use an HP calculator, paper, and pencil, but then so does the world’s richest investor from Omaha, NE.

  20. You did not include the $800 per month that the renter gets to invest at 10%. The buyer is investing that $800 per month at 7%. Of course he is going to have a higher net worth.

    Quiz: What percent of the population has a household income of at least $96k per year?

  21. Rhonda, Happy Birthday!!!!!!

    Yes I was referring to capital gains. Not sure if it figures into the discussion comparing different asset returns.

    If I’m busy shorting the financial institutions, I’ll be paying short-term capital gains on my positions. If I’m taking the money I save on a mortgage by renting and tying it up in a tax sheltered vehicle, then I’ll have trouble accessing it until retirement.
    Primary residence has been pretty beneficial to some I know who have been willing to move every two years and capture all their appreciation tax free during the recent home price boom. Historically I have failed in my attempts to make money in the equities markets other than long-term buy and hold. I have ‘guessed’ wrong or my researched positions have been buffeted by those with insider information.
    Most common investors have a well-deserved distrust of Wall Street and are probably much less sophisticated than some of the learned posters in this thread. Faced with a deck that seems stacked against them, ‘investing’ in their home seems safer. With an endemic lack of discipline many individuals feel like a forced savings plan is better than the alternative. It may be lazy but better than blowing that wad of cash on conumer goods or guessing wrong on the stock market.

    That said, I can understand any buyer being EXTRA cautious at this time.


  22. Michael:

    I have a platinum HP Calculator 12c (courtesy of Bloomberg) on my desk too along with my mechancial pencil (courtesy of my time at the UC Berkeley Graduate school of engineering).

    I ‘geeked’ you all out (MSAs, MatLab, SAS) as that is my day + night job, looking at aggregrate credit risk of various asset classes — HELOCs, HELOANs, Whatever — for various, say, ‘participants’ in the credit market. To this end, we employ a variety modeling strategies and these modeling strategies require both analytic frameworks and calibrations/inputs of various critical variables. Sure, I’d love 7% yoy gains in a decade for my real estate asset class … but its not going to happen. Period. The sooner we all accept this, the better it will be. Appreciation is OVER, DONE, FINISHED for at least the next 5-10 years.

    Instead, the topic du jour — since at least Q2 2006 — is “how bad can it get”, eg, what would happen if the 91-95 ca housing recession happened again OR if Japan’s 14 year long housing slide happened to america OR if credit spreads widened. No answer, in public :), but for each of these and other scenarios, HP calcs don’t cut it …

    RE your paper on housing as an asset — sure, housing is forced savings and sure if i bought in palo alto in the 70s, i’d be rich (people win the lottery every day!) — but other studies, schiller comes to mind, state the opposite – in real inflation adjusted terms, the net amount of REAL housing appreciation in america for the past 100 years is basically 0. 0% after inflation.

    Don’t fight the tide (per Buffett), don’t pick up dimes in front of an oncoming freight train (per me) , POWERFUL forces are pushing the real estate asset class back to historical appreciation norms and, doing the math ON MY HP, this would mean that housing prices are going to slide hard in the short term OR just stall at flat prices (as japan did for 14 years) for at least the NEXT 10 to 15 YEARS

  23. While the Mortgage Professor has his marketing shtick for lenders as Rhonda pointed out, his calculators available on his website are correct. The inputs and calculations may seem technical and extensive; they need to be for an accurate result. A simplified version may lead to the same decision, but the calculated result used to make the decision may be significantly different leading the user to believe a different level of severity. Any calculation of costs or income beyond one year must include a discount rate with all the cash inflows and cash outflows.

    Here is the link to the rent vs buy calculator.

    Michael P. Lindekugel
    Financial Analyst
    RE/MAX Commercial
    Team Reba – RE/MAX Metro Realty, Inc

  24. I have a question here:

    what are the chance that inflation will go up again in the next 5-10 years?
    If it does, as long as I have a fixed interest loan, does that mean I will get a free boost on my return?

    how long can today’s low rate last? If the interest rate goes up, even if the house price goes down, doesn’t that mean I will still pay the same amount of money, only get a smaller house?


  25. finance_guy,

    I have 14B from 1985. It still runs.

    I see your point about the 7%. I wouldn’t have used 7% for my own analysis. The local economists are using lower numbers and I trust their calculations. I don’t use SAS because I am not developing the assumptions such as 7% capital growth. We rely on others for those inputs. We generally stick to the financial due diligence and perform less statistical modeling.

    In the commercial space, low to no capital growth isn’t so bad. Most of the historical yield on commercial property is from the cash flow from rental operations and not the realized cash flow from capital growth upon disposition of the asset. Our commercial space is very hot right now. I would like to see it cool down. In the residential space we are experiencing a slight slow down in the number of transactions in the NW, but we are not seeing a decline in the median price. Our rate of growth has slowed somewhat. Our historical average since the early 1990s is around 7%. Longer term it is 1 to 2 percentage points lower. The NW has some pent up demand. We do not have enough construction and permits in the pipe to house the current population.

    Anyway, Happy Friday.

    Michael P. Lindekugel
    Financial Analyst
    RE/MAX Commercial
    Team Reba – RE/MAX Metro Realty, Inc

  26. Michael:

    first off topic about HP. some years back actually was at HP (yes working on a credit deal) and got to meet the head of their worldwide calculator division. We talked about the HP 12c of course. He indicated that when it was first built, the chips inside actually took a few seconds to do PV, PMT, etc calcs so the put in the flashing “RUNNING … RUNNING …” screen display. Cut to today, the chips in the 12c can handle these calcs in milliseconds but they still made the calculator display “RUNNING … RUNNING …” as people so associated it with the HP 12c…

    Back on topic, specifically Pac NW real estate, no math here

    RE Pent up demand, it exists, as I have a pent up demand for a mansion. Ha ha ha. All kidding aside, i’ve seen these studies trying to forecast demand, eg, seeing more single people, more divorced moms, whatever driving “household creation” and then, magically, labeling household creation as a proxy for real estate demand. Pretty thin analysis if you ask me.

    We can compare notes on this study or that but this is pretty meaningless exercise for two reasons 1) demand doesn’t translate into sales IF PEOPLE CAN’T AFFORD HOUSES and 2) when pent up demand DID translate into sales (2001-2006), these sales were only facilitated because home mortgage underwriting standards were basically thrown out the window.

    Once again, no math here: People cannot afford the houses they want, even in “non-bubble” seattle. Data point: 1/3 of Seattle mortgages originations in 2006 were Interest Only or Neg-Amortization. US average was 23%. Seattle neg-am, io share of originations was roughly the same as that in wobbly housing markets as Phoenix, Modesto, and Stockton. People who can afford houses by an large do NOT go IO or Neg Am (if they were prime, they would lock in today’s low rates, if they were rich, they pay cash). When this garbage resets in 2008 or 2009, you will have MORE inventory flooding the market. This is not a good thing for house prices.

    I’ll stop here before i go on to investor real estate purchases (eg, californians buying things up) and before i detail a view in many quarters that the US, as a whole, has OVER invested in real estate over the past few years (i’ve heard this called the “martha stewart effect” as she helped validated that it was OK to spend 5f0K on a garden). I think buffett or someone of his ilk stated that “A house is nothing more than a wooden box that stands out in the rain and slowly rots.” Housing is not a productive assets. It does not contribute one iota to the productive capacity of the US.

    Housing has boomed but that has stopped and now we are heading for a bust.

  27. Here is another mistake in the analysis. This couple would be in the 25% tax bracket, which tops out at 128K AGI. Remember, AGI is your W-2 income, which is income AFTER all the payroll deductions, so a couple earning up to 150K could still be in the 25% tax bracket if they do their payroll deductions right, especially 401(k).

  28. You call yourself a mortgage planner and you don’t even know that the word is principal, not principle?

    After I saw that I found it difficult to take the rest of your analysis seriously.

  29. KC…sorry I forgot to mention that I’m human and just might make a typo every now and then. I’m still celebrating my birthday so I won’t be around to comment at RCG today.

    Happy St. Patrick’s Day!

  30. Hi everyone,

    For those who have an opinion one way or another, I have this basic question for all of you:

    Who here are renters, who here are home owners?

    finance_guy, while I value your posts, I am curious are you a home owner? Same for the others.

    Real Estate people have a vested interest, they want people to buy buy buy. Renters are jaded and are hoping for the real estate market to crash. Home owners of course will believe anything that shows a positive forecast.

    Simple question: do you guys own or rent?

  31. I rent and I’m hardly jaded. The house I rent was purchased for 435k and then had 75k in remodeling done during the past 9 months. I rent for less than half what a mortgage on the place would cost me with a traditional loan product. And again, the PLACE IS LIKE NEW.

    I cashflow the money I save from renting (~1500 a month) and put that towards other investments (IRA, my stock portfolio, cd’s) etc.

    Buying a house just doesn’t make sense to me when I can cash flow the difference from renting vs. buying. Sure I could leverage myself into a house but then I’d be a slave to the mortgage payments. No thank you.

  32. I own 🙂 I admit that all this talk makes me stop and take stock of the whole situation. I love my house. It is one of the joys of my life. The value could go down and I’ve considered that, since I haven’t owned it long, and bought it in truly peak market times. But I’ve decided decreasing my quality of life is not worth the potential savings. Money isn’t everything.

  33. Dan:

    FYI: We’re in a posh area of the Bay Area and rent a 780K house for 35% of what it would cost me to buy it.

    So that makes me an “angry renter” … Actually not. I don’t want housing prices to collapse as this would have severe repercussions to the larger US economy and, closer to home, my income as I am heavily involved in the mess that real estate created (NOT in foreclosures or anything like that but I’m involved in interest rate risk management, an area greatly distorted right now by all the craziness in housing).

    Why don’t I buy? Its not that I can’t afford the house I live in (the owner, who loves us, is an out of state guy who inherited the house) or any of the 1 – 2 MM $ houses on my block. Let’s just say my area of finance ha$ been very rewarding the$e day$. First, I don’t buy because we like our home(stuffed with design within reach stuff and artwork), Second, we’re too busy to move (I travel to LGA and LHR and NRT a lot). but Third, it just simply doesn’t make economic sense to move.

    Flat out, it would be a STUPID economic decision to buy in this falling market. Yes, I have my data points — example, a house on my street sold for 15% under the wishing price, ouch. Moreover, I don’t need a house purchase to “force” me to save. I’m very very happy to sit on the sidelines, spend less than 10% of my income in rent, save over 35% of my income, protect my > 780 fico score :), send my kids to private school, go on lots of trips, and go to bed every night NOT worrying about a balloon payment or interest rates, or earthquakes or fixing up the house.

  34. FG,

    How do you know the “wishing price” wasn’t “wishful thinking”? How does one know that the market is down simply because an owner doesn’t get what the wished for? Wouldn’t it have to sell for less than a similar home sold for recently, for the market to be “going down”?

    Not saying it isn’t going down there, but I was just in CA and I saw it being more flat than down. Seller asking for way more than the last one sold for, and not getting it. But still, no one near selling at a loss.

  35. Ardell:

    At this point in the (inner) SF Bay Area, its a standoff between buyers and sellers. As you observed, sellers want 2004/5 prices while potential buyers aren’t opening their wallets. No “spring bounce” around here — sales are slow slow slow and what sales do happen are at prices less then desired. The (outer) bay area IS hurting much more: Brentwood, Antioch, Tracy, etc have seen price declines and spike in foreclosures.

    That all said, as this real estate run up happened over multiple years (from about 1997 to peaking in Q4 2005), we are very very early in the process to say we’ve hit a bottom or that prices will stay flat. This process is definatly NOT going to be like the Nasdaq crash (= over a few months) as housing is far less liquid.

    Everything I see/read/hear though, forces me to err on the side of extreme caution and not expect the best with regard to housing prices. Why?

    1. The effects of the subprime collapse is spreading – very very fast – into Alt-A (the next level up) lending. While my area didn’t have that many subprime loans, we do have lots of Alt-A paper

    2. Over 1 trillion dollars of ARMs are resetting this year. Resetting in the face of flat/declining valuations + much tighter lending standards. If people can’t roll their loan, they will have to pay much greater interest rates. If they can’t pay this, they will have to sell or they will get foreclosed on (and the bank will sell)

    Finally, go to google video and look for this video
    3. “Economics Roundtable: The California Economy — Housing Boom or Bubble?” A feb 2006 talk by an economist the housing bubble. Specifically talks about how “all those subprime lenders along the 405 in Orange County” are going to get hammered – WHICH THEY DID — and provides a very very thorough analysis of how a decline in house sales (as we are seeing now) is a precursor to significant price declines. Video is 55 minutes but very very worth it.

  36. Thanks FG. I saw prices still double 2001/2002 prices in L.A. Beach Cities and holding, with possibly a 5% variance. Too early to call on that. I’m still hoping for a Condo in Redondo or Hermosa at 2001 prices. Willl let you know when they get there.

    I saw a lot of “living off equity” in CA. People literally borrowing out their equity each year to live on. Consequently I expect to see more foreclosures there than anywhere, even if the market stays flat. Some people are going to have to find another souce of annual income.

  37. Ardell:

    SO true “foreclosure even if prices flat.” WHy? your observation about people “eating their houses” (= living off of HELOC draws and serial refinancing). Other reasons:

    1) Negative amorization, option arms, and similar types of lending toxic waste. Getting a 2/28 or 3/27 loan with a 1% teaser rate in 2005 means that in 2007 or 2008 your payments are going to go up sharply + you can’t count on raising home prices to bail you out

    2) Real Estate + home furnishing, gardening, remodeling, etc is huge portion of the california economy. With flat house prices, people aren’t going to buy as much, refinance more often, etc. THese jobs are in danger (or gone given the mass layoffs at New Century, Ameriquest, etc)

    3) Investors are bailing. With flat prices, houses bought during the boom suddenly look less valuable. These houses are hitting the market.

    etc etc etc

  38. Thanks for the info guys.

    finance_guy, for someone who makes 160k in the Seattle area and looking to buy his first home, what would you advise?

    I’m currently renting (and fine with it so far), but financially also ready to buy down into an entry level home (400-500k) in the Seattle area.

    People here are still making multiple offers and trying to outbid each other on the great homes, the so-so ones are sitting on the market for months. Who are these people? Stupid? Ex-Californians? People like myself just deciding to bite the bullet?

    How long should I wait? What are the signs I should look for?

    I would also appreciate the advice of others here, but please include your background: realtor, home owner, renter.

  39. Dan, I own and a I am a REALTOR(R) but I have only been in real estate for just shy of 4 years. I’ve owned homes and investment property for over 10 years now and I’ve made money on each and every one of them. I prefer owning over renting because I can do what I want with my home – and I couldn’t in a rental. Yes, I have the costs of home ownership but I also get the gains. You as a renter don’t have control over whether or not your rent goes up other than to sign a time limited lease. I do have a choice to get a (now) reasonably good interest rate mortgage on my home and limit the amount of my housing payment for the next 30 years if I choose to live here that long. I also get the capital gains up to $250k tax free when I sell it and my house has appreciated that much (and more) since I bought it 5 years ago. That’s a lot more than I have been able to personally save from income and I was able to get leverage so my home is one of my best performing assets. My stocks have done fine but I don’t put as much into them as I used to now that I run my own business – I put most of my investment into myself and my business for now and am happy to say our business is profitable in less than 4 years. I also own rental property that brings me additional income each year and at higher levels than my stock dividends.

    If you’re making that much each year you can easily afford to purchase. If you’re concerned about not having money to do other things then you must be wasting a lot of dough on other consumer items or you are stingy with your money. When I was working in the tech sector I was at the same income level as you and I felt like I had a lot of extra at the end of the day even after paying for my mortgage, 401k, other retirement accounts, and such. I traveled at least 2-4 weeks out each year overseas too so it’s not like I didn’t take vacations. I don’t get vacations now because real estate is very different than the corporate world and people expect real estate agents to work at all hours and be at their beck and call so it’s harder for us to get away. That isn’t a complaint, it’s just how it goes. Because we’re all self-employed it is hard to find another agent that will take over a busy work load from another agent for several weeks and it can be even more difficult to find an agent that handles their business similarly.

  40. Dan,

    What would be your motivation to buy? What advantages would there be to you, your quality of life, to buy vs. rent? How likely are you to stay in the property you purchase for five years or more?

    There has to be a reason to buy besides what you have said so far. That you “can” is not a good enough reason to buy. What personal reason would you have?

  41. Ardell –

    The motivations:
    – Having a home to call my own gives me peace of mind knowing that where I live is my own, and not a place that can be taken away from me.
    – I like having the option to landscape and beautify something I own, not something I rent.
    – If the property appreciates (over 10+ years), why not? I’m not a flipper.

    Reba, thanks for the info. If the market is slowing, what is wrong with waiting a couple of months or another year? I can save up more so I can put down even more.

    I am concerned about buying a house because I can not assume that I’ll always have my job. What if I’m injured? What if I lose my job? The money I have saved up will offer me a safety buffer for years. But with a house down payment and mortgages, that buffer will last only a few months. Also things have been great for you the past couple of years, but what if things go down in the next couple of years? I can just buy in at the bottom right?

  42. Dan:

    Every person’s financial and personal situation is different, and houses are the largest purchase a person typically makes in their lifetime, so I don’t really have an exact answer for you via HTTP (particularly now as I am very jet lagged in NYC right now).

    Here is how my analytic brain approached the rent/buy ?:

    First/Foremost: I built a financial model in Excel. Includes various real data points about closing costs, local property taxes, insurance, maintenance, amorization schedules for various major systems (roof, heating, appliances), down payment assumptions, opportunity costs for the funds I tie up in a house (eg, I could be earning about 3.7% after tax risk free on any funds i spend over/above my rental costs to buy a house), mortgage interest rates, and the cost of an equivalent rental (not necessarily the place I live in now, instead, it would be how much a house similar to the one I am considering cost to rent). Critically, I also put in an “assumed appreciation” line where I put in various YOY (year over year) depreciation and appreciation rates: -8%, -5%, 0% , 5%, 7%. Stress test ALL your assumptions, as, what would happen if housing prices stay flat OR if taxes go up, etc. I personally think this is FUN but, then again, I’m a credit wonk.

    Building a model is KEY for so many reasons: It doesn’t cost anything (get open office if you don’t have excel) and it really focuses the mind, particularly when you advance towards buying a home and you start getting hit by a wave of financial, um, “stuff”. (Doing your thinking, first, in Excel, will save you from signing on to neg-am, io, option arms, and similar toxic waste)

    As you advance towards looking to make a purchase, Before going to open houses and the like, I would first line up at team, starting with your significant other. Yes, buying big things as houses could stress marriages and relationships (!). Work through the numbers together, talk about if what you want (urban, suburbs, one story, two stories, etc), etc etc etc. Once again, talk is free.

    I would also add to your team 1) a lawyer and 2) a contractor. I would ask your friends for recommendations. Go to #1 and #2 and ask if they were willing to make a few hours of income if/when you get serious about a house purchase. All the contractors and lawyers I know never pass up a chance to make money (!) but, more importantly, I’m sure you can find some objective people in each field, to help you out.

    I would also consider adding #3, a real estate guru, to your team. Could be a buyers agent but I’m thinking more about someone in the industry (eg, someone who has been a developer for years, an older friend of your family who has been in real estate a long time, etc) who isn’t compensated only if a sale is made. Spend the money and hire someone, once again for a few hours, if/when you get serious about a purchase.

    Now, I think you are ready to start looking as you have your model, your simulations, your spouse/sig other, and your team assembled. I would start going to open houses, say, 20 or so over the next few months. Feel out the market, check to see how motivated sellers are, check to see if houses you have been to have sold. NO RUSH HERE. I would go to as many as you can to “feel things out.” For properties you are interested in, ask your real estate guru to run a title report (shows prior sales, mortgage amounts, liens, etc). Pay your contractor to go with you to a few open houses (“undercover”) and have him/her point out various things about the house (water stains on stucco, sloppy finish around electrical sockets, an undersized water heater, etc). Again, NO HURRY TO BUY, just collect data.

    If when you find a house, again, sick your team on it. Pay the lawyer to review EVERY document, pay your contractor to really give the house a once over, have your real estate guru feed you real time comparable sales, and, once you start arranging financing, have your bank or mortgage broker bend over backwards for you.

    One more point, when you are ready to move on a house, I would also seriously consider making a lowball offer. Try it out. Inventories are spiking everywhere. Ensure that the realtor you are talking to presents it to the owner. Don’t know the legalese about this in WA but I think in other states they have to present all offers they receive. It just might be accepted and you would save tens of thousangd over the life of the house. I know I know, this is a tough negotiating tactic (“yeah, i see your house listed at 580K. As we all know, the market has changed. My first and final offer is 450K. If you accept, we close the deal in two weeks. If you don’t accept, good luck finding another buyer because I’m not going to move off of 450K”) but its YOUR money and YOUR future payments on the line. Be VERY VERY VERY tough with everyone who aims to make $ off of YOUR completed transaction.

  43. Dan,

    Buying the house I own right now was the scariest thing I’ve ever done in my life, for a lot of reasons. When I bought my first house I had worked at “the bank” for 10 years or so by then. I wasn’t afraid of losing my job. I was getting married in about six months. No fears.

    Buying this house after my divorce, all on my own was scary. I literally moved here with what would fit in my car, and slept on a mattress on my sister’s library floor until I could get myself going after having been married for 20 years. After living in beautiful homes all my married life, it was scary…real scary.

    After work today I came home and scrubbed down the green spots on the siding with a brush and bleach, on the part of the house that gets no sun. I was just loving taking care of “my house”. I love painting a room bright turquoise and not having to ask someone if “I’m allowed”. My home brings me great joy.

    What will improve the value of my home is what I do with it and also, in my case, what happens to the neighbors on either side of me. If they become $1.4 million dollar houses, which is likely before I move, That will increase the value of my house to about $980,000. Most often it isn’t market conditions, but other factors that create value. That’s why buying the cheapest, and sometimes ugliest, house in a good neighborhood is usually the better choice than a house that says WOW! with everything perfect.

    I’m kind of rambling. I don’t see the market going down, Dan. I see every house selling for more. I have had two clients in the $350,000 to $450,000 range, one lower and one higher, one without kids, one with…looking for two different types of housing, since July or so. One is closing on a newer townhome soon, after looking at single family homes up to $465,000 or so in Green Lake, Greenwood, Ballard etc… the other looking at anything and everything up to $425,000 or so in Lake City and all areas Seattle North or Downtown.

    I’ve seen just about everything that has sold (not every townhome) for $350,000 and up worth seeing over the last six months. In your price range, I think you need to want your own home. The rent vs. buy doesn’t cut it. The advantages aren’t in your face obvious, as most of the single family homes in your price range are basically “passable”.

    Speaking of which, as you’ve been thinking, have you seen anything that you would say “Gee, I really wish I had bought that!”

    Sorry for rambling. Just thought something up there would be helpful in your thought process. It’s been an odd day of scrubbing my porch and house while waiting for the answer on another multiple offer on a house in Seattle priced at $430,000 or so. Things are bidding out. Generally more than one offer in your price range. I truly don’t see the market slowing down in your price range at all.

    That is still not to say you should buy, not even sure what part of Seattle you are looking in, but if it is in the Ballard, Green Lake, Greenwood, Phinney, Lake City, etc…area, I am not seeing the market slowing.

    I’m wondering if Shoreline might be the best gamble in the lower price ranges right now given the school situation there causing uncertainty. Or maybe Kenmore.

    Rambling again. Best to stop typing 🙂

  44. FG,

    In Dan’s price range in Seattle…not much stays on market worth having. Lining up 20 houses to feel out sellers is not realistic. I’m assuming Dan’s from around here somewhere. Maybe not. I saw a house for $1.3 mil “sitting” in Green Lake, but $400,000 to $500,000? In some places the dirt UNDER the house is worth that much. The dirt under my house represents about 80% of the home’s value 🙂

  45. Ardell and Reba,
    Is it just me or do home buyer’s expect more for their first home? I guess rightly so if a starter home cost $400k. When I bought my first home in ’89, it was not my dream home. I was just glad to get my “foot in the door”. We sold it the next year and gained our down payment for a home that I liked better. I just wanted to own a home (granted, it was FHA minimum down…the bank owned more than we did…but I could paint it, plant a garden, carpet or not!).

    Just curious if you’ve noticed a trend with buyer’s expectations.

  46. > hen I bought my first home in ‘89, it was not my dream home.

    Rhonda, what was the spec of your first home? 2 bed 1 bath? A 2 bed 1 bath runs 350k minimum here. What is that home back in ’89 worth today? That’s right at least 400k. And that is what it costs here to get a home in Seattle that isn’t run down.

    I make enough to afford the monthly payments, so what’s wrong with looking for a 450k home instead of a shed for 100k?

    There is no trend with buyer expectations, homes just cost a lot.

  47. To Dan:

    If you don’t to spend all your time commuting from some distant/faceless burb, as seattle (like the bay area now) seems to be shutting out first time buyers, I would rent. I don’t know seattle well but, the few times I was there, I liked Green Lake area alot. I spent 3 minutes on craiglist seattle and found this rental (“Absolutely fantastic 4 bedroom 2.5 bathroom home on a quiet street! …” ). 2600/month for one of these purpotedly 1.3 Million dollar houses

    Here is the address: 718 N 79th St Seattle WA US

    Rent a million dollar house, save your money, go on trips (We’re off to Mongolia in July) and be happy you don’t have a depreciating boat anchor around you neck.

    Some perspective for you all: Dan seemingly is making a very very good income (160K a month is probably in the top quintile of households in the greater Seattle Area). Yet Dan can’t afford a “starter” house unless he sacrifices a huge amount of his free time commuting and/or signs up with a toxic loan hoping for house appreciation to bail him out. On a macro/regional level, How sustainable is this???? If people with good income can’t buy, how sustainable ARE house prices. Remember, the boom was caused by lots and lots of demand. IF the demand STOPS, either because buyer psychology changes and/or lending stands tighten up, are prices sustainable?

  48. WOW!

    I bought my first house in Dec. of 82 for $45,000 and sold it about 18 monthslater for $65,000. Zillow has it today for only $74,000. I made more on it in 18 months than it has increased in 12 years since? Maybe that’s assessed value and not Zestimate.

    Same for my second house that I bought for $115,000 and sold for $175,000. Zillow has that one at $183,400. I sold it in 91.

    My third and fourth houses are worth double what I sold them for back in 92 and 96. I must have moved up to a better neighborhood by then. A lot more appreciation.

    I guess it’s not only about knowing how to pick them when you buy them. But also knowing when to “trade up”.

  49. Dan,
    Ardell inspired me and I zillow-ed my first (and a couple there after), too…and to think I’ve been using title company comps and doing this the hard way!

    When I bought my first house, I worked for Chicago Title in Seattle, we had just moved into the Columbia Tower (it was brand new). The only place we could afford was NE Tacoma. I had a terrible commute. But I was thrilled to own a home. Looking back, my purchases have mostly been emotional over economical. However, they have turned out to favor my financial interest quite nicely. The house is a 3 bed/1 bath, 1008 sq. feet. I was 21-22 years old and paid $60,000, the next year, we sold it for $90k. It now zillows for $244k.

    We used the proceeds to buy our next house, which was new construction and the plat was called “The Affordable Street of Dreams”. Our 1500 sq. foot home on a small lot cost $128k in 1990. It recently sold for $303k.

    We then bought what we thought was our “dream home” for $200k in 1993. And divorced a year later…was it all that upward mobility? Too much spending (I think it’s actually that we married very young)… it now zillows at $433k. (Dream home for us with 1 young child was a 4 bed/2.75 bath on a 1/4 acre backing up to a green belt on West Hill Auburn).

    I rented for 6 months in an apartment and crawled out of my skin. I’m really learning a lot reading what people who rent successfully have to say… for me, I just cannot do it. I value owning a home…I grew up renting and was the first person in my family to purchase a home.

    Anyhow…I bought my post-divorce condo in 1994-5 in Des Moines for $128k and sold it in 3 years for $174k cash in 4 days. It now zillows out at $289k. It’s a 2 bed/2 bath with no view…nice finishes. 1100 sq. feet.

    I then bought my dream “single girls” home on a lake in West Hill Auburn for $317k and sold it in 2005 for $515k…and moved in with my now husband.

    Have I just been lucky each time? The divorce house we did not make money–we maybe broke even (I would have to dig up our huds from way back).

  50. > 160K a month is probably in the top quintile of households in the greater Seattle Area

    That is annual, not monthy =]

    Lenders are telling me I can secure a much bigger loan, but I always used these simple calculators: spend 1.5x what you pay in rent, never part away with more than 30% of your salary into a home.

    Ardell, curious – what area are those homes?

  51. Well it’s which State, not area. My first house was in Philly, 2nd in Cherry Hill, NJ, 3rd and 4th in Newtown Borough, Bucks county PA, 5th in Lake Mary Florida, 6th in Granite Bay, CA, 7th in Manhattan Beach CA, 8th in Kirkland WA, a couple of rental houses in between while waiting for my houses in Lake Mary and Granite Bay to be built. and a rental apartment here and there during relocation and divorce.

    My ex is a CTO. We got around a bit from 1996 through 2001.

    But I have seen some areas here in Seattle (Eastside actually) go up 70% in 18-24 months and others (a 15 to 20 minute drive away) go up only 16% in the same period of time. Never use County-wide averages or National news to make local real esatate decisions.

    That $430,000 house in Seattle had many offers today. Lots of issues at that house, but still went for at least asking price. Multiple offers are not “a thing of the past” and the market is not slowing down. Don’t be fooled by the media. 2007 is not going down around here, not even close.

  52. I want to point out Finance_Guy said “Housing is not a productive assets.” That is the basis of the finance and economic decision analysis for rent vs buy. A mortgage has an opportunity cost of the cash flows that are not invested in a productive asset. For the most part, the rent vs own calculation results are about equal in the long term. Generally, a home is not a good investment. Many graduate schools and The Fed have published papers on this topic. Nationally syndicated columnist Kenneth R. Harney, Jack Guttentag (retired Wharton Finance professor), and Scott Burns have published many newpaper articles on this topic. The bottom line is purchase a house because you want to own the shelter covering your head.

    Any lender who tells you a home is an investment and proceeds to show you the graph of appreciation making you wealthy failed. The lender fails to have a basic understanding of discounted cash flow analysis. The lender failed to include all the cash inflows and cash outflows including opportunity costs and tax treatment. The lender is showing you a short term picture. In the long term the after tax yield of all asset classes are close to each other. No asset class provides significantly superior after tax yields above other asset classes. Finance and economics 101.

    Michael P. Lindekugel
    Financial Analyst
    RE/MAX Commercial
    Team Reba – RE/MAX Metro Realty, Inc

  53. Michael,

    You’ve got me thinking again. Of all the conversations I’ve listened to with clients sitting across from me signing loan documents, I can’t think of anyone that ever mentioned “I’m buying this house because it is shelter.” Rather, the conversation seems to always center around the “equity that I’ll make” or “it will be a great investment.”

    Don’t get me wrong, I’m all for perceived equity while a homeowner and actual equity realized when I sell, but if homeownership is a rather equal/mundane asset class in comparison with others, then where do consumers get the idea that real estate is head and tails above many others? Where does that mindset come from?

    The only way I have found to somewhat hedge against possible market swings or loss is to purchase really terrible condition homes including the one I reside in and slowly improve them, smartly, over time as the budget allows. The ’90-94 ish market in Seattle taught me better than my classes at Seattle Pacific that homeownership is not without potential pitfalls and cost. Reminiscing, I recall my very first home improvement project (1989) on Queen Anne on 10th Ave West (I was not the owner) and watched the owner lose tens of thousands due to mistakes and the market going flat. I think interest rates at that time were around 10% or so.

    I read recently (can’t recall where) that the r.e. gains realized over the last few years (appreciation/inflation depending upon one’s perspective) have been superb, only to continue reading that the reality is that the US dollar has dropped in value and is worth less. I’m still trying to sort that out.

  54. If you put all of your eggs into buying a house or all of your eggs into the stock market (or like investment) and the stock market crashes. You’ve lost everything with stocks…even if the home depreciates significantly, you do have “shelter”. I’m not saying that owning a home is the best or only investment and I have learned a lot from the RCG readers who are renting currently. I can say, from the clients that I’ve worked with for the past 7 years in the mortgage industry, that for most of them, their home IS their primary investment. They may also particapate in their 401k at work. I would say 30% have a diversified portifolio. Most are not set up for retirement and do not save. This is where I’m coming from when I state that this is an automatic savings program for many home owners. Ideal? No. Are these buyers better off than if they were renting? Yes–IF they are not savvy investors.

    I commented last night….it was probably too long and I’m afraid it went into the RCG spam-basket…so I’ll cut this short to. It was about how I’ve done on all of the homes I have owned and sold.

  55. Rhonda – I missed your post since I was posting a response to FG when you posted.

    >Have I just been lucky each time?

    There is luck and strategy to any investment. Looking today, pretending you are in my situation (possibility of a falling housing market in Seattle), would you invest in property today?

  56. Hi Dan,
    When I bought all of my homes, I was in the title industry and never really paid much attention to market conditions or trends. I’ve bought every home because it is where I wanted to live. The appreciate was a side-benefit. I was very spoiled to have a 50% return on my first house in one year (even though it wasn’t huge dollar amounts, we’re talking a 60k house selling for 90k).

    If I were renting and considering buying right now… if I saw the house I wanted to live in, then yes I would buy. (I say this not knowing your financial info). Especially if it is what would be considered a “starter home” in the Seattle or Eastside area. These homes will always be in demand…everyone needs to start somewhere. And as I mentioned (post 54…my long email showed up), I grew up renting and so for me, I have this odd need to own real estate for security. I don’t expect housing prices to fall in Seattle. Homes that may be overpriced may sit (and should).

    I live in West Seattle and just a few weeks ago, a home went on the market across the street from me for $495k, I saw people running to it. It sold immediately.

    My personal motto has always been, if you like it–buy it (houses that is). And it has served me well. It may not work for others.

  57. Tim,

    The 1990s the asset class of choice was the stock market for the IPOs and tech stocks. In the early 2000s the asset class of choice real property.

    Investors move capital into asset class A because they perceive this asset class provides superiors yields. The limited supply and increased demand create upward price pressure for assets in class A. At some point investors perceive asset class A prices are too high for the yields. Investors begin divesting capital from asset class A. The freed up capital is moved to asset class B because investors perceive this asset class provides superior yields. Asset class A prices begin to decline from less demand and increased supply from the divesture. Asset class B prices increase because of investor demand and limited supply. In the short run, one asset class can out perform other asset classes. In the long run, all assets classes will provide similar yields. Investing in different asset classes provides hedge against asset class risk. Investing on a regular basis provides a hedge against time and price. You are less likely to acquire an asset on a down spike or an up spike.

    It wouldn’t surprise me to hear the latest real estate run was the best ever. The last stock market run the 1990s was supposed to be the best stock market run. I think widgets will be the next best asset class for investment.

    I think the mindset comes from the marketing guru spin. I would not consider home ownership to be an asset class. Home ownership is not a productive asset. I would consider real estate investment such as rental property an asset class. A few stock brokers might tell you they had an inside track to get you IPO shares. Nice. The Friends and Family (employee) round prior to the IPO are the ones that really made it big. The IPO may have had more than one round. Think of all the tech stocks. The (crappy) business plan called for five years of red ink for something to do with the Internet and selling to VCs at the end. Some people made money. Some people got burned.

    The Fed has raised short term interest rates which has a huge impact on short term mortgage interst rates. The Fed has just about no influence on the bond market. The bond market has a big influence on the longer term mortgage interst rates. Long term mortgage yields haven’t changed as much as expected. Bond investors are not seeing inflation as a huge problem at this time. Today, we have more international investors holding our bonds than anytime in history. Our bond market is much more international. They see the US economy as safe for now.

    Michael P. Lindekugel
    Financial Analyst
    RE/MAX Commercial
    Team Reba – RE/MAX Metro Realty, Inc

  58. i am a renter. when the value of my home kept doubling i sold. my property taxes also kept doubling!!!!!! no one seems to ever talk about property taxes and what a waste they are. if i had stayed in my home i would have paid thousands in bogus ‘appreciated’ prop taxes.

    i bought my home during the last crash – yes RE does go down and i paid 50% of what the owner had ask 1 year earlier.

    bought reits for awhile and then gold. keep dumping the returns back into my savings account.

    i will buy a home again when the prices get back to normal but i expect the prices to fall way below average. thisis going to be brutal for the next decade………

  59. i am a renter: “but i expect the prices to fall way below average.”

    Why do you expect them to fall below average? Wishful thinking because you rent or do you have some interesting analysis to indicate otherwise?

  60. David:

    There is plenty-o-analysis here about why housing’s price spurt of the last few years is not sustainable going forward. Need more? google “Roubini” or “Stephen Roach Great Unraveling” to get pretty bearish analysis on housing. (Both guys are very well respected Wall Street guys from this guy, who is also a wall street guy :>)

    Housing is stalled right now – even the National Association of Realtors admits this in their data that shows year over year price declines in many markets. Wishful thinking at this point would be thinking that housing resumes its upward growth in appreciation – its wishful/fanciful to think this in March 2007 given the fact that everyone is tightening credit, dozens of subprime lenders have been blown away, and many of the financial innovations of the past few years (Neg-am loans, IO, option arms, etc) are coming back to seriously maul people who took out these loans.

    Why does this matter? Three reasons: 1) if people have no money, they can’t buy, 2) if people can’t afford a house with a toxic loan, they will try to sell it, and 3) the more people try to sell, the more they put pressure on prices/comps. Much as the boom was caused by people leveraging up to buy as much as they can as they saw prices go up, on the way down, psychology will play a huge part too as when people see houses prices decrease, many many will rush to the exits to try to get out first.

    We use this term in my areas a lot: “getting one’s oxygen cut off” (example,, Worldcom, Enron, etc had their oxygen cut off in various boom/busts over the last decade when liquidity for their respected asset classes diasappered). Same thing happening with a large chunk of housing assets now. (Open to your data showing otherwise, feel free to share it with us).

  61. I’m actually reading those links you sent, thanks Finance Guy.

    I have no opinion right now. I am a renter, but I am not wanting a housing or economic crash as it could negatively affect my job (and thus quality of life). I’m happy renting but would like to own a house for no reason other than to say “this house is mine”. So as long as the house appreciates in the long term (5-10+ years) I’ll be content.

    I’m also looking to buy a home in the Seattle area and just made and planning on making an offer on a entry level house in a couple of days. Should I wait it out one more year to see what happens? Or just buy in? Yes I know all the benefits of renting, but I value geographic stability (I don’t want my landlord to kick me out). I can easily afford mortgage payments (even at current Seattle prices) and have plenty of saved cash. If homes depreciate in the next couple of months, I’ll just wait and buy in then. Or should I just buy in now?

  62. First time Seattle home buyer here.

    Wow, I am making an offer on a house right now. Timing is interesting with this subprime fiasco 😛

    I’m curious about interest rates and home prices.

    Short Term – Loan rates are benefiting because the stock market is taking a beating, causing money to flow into Bonds and Mortgage Backed Securities. This benefits home loan rates. Home prices will remain steady.

    Long Term – Higher interest rates, as lenders have to absorb the cost of the loans that went belly-up, combined with the cost of increased compliance and accountability standards. House prices will indeed go down. How much lower? Who really knows?

    So my question is this, I’m new to Excel and I want to calculate how my interest rate (6.2%

  63. Damn I got cut off.

    So my question is this, I’m new to Excel and I want to calculate how my payments currently (6.2% on a $550k home, I put down a little more than 5%) would compare to the future (higher interest rate, but depreciated home).

    How do I calculate timing? Buy now with low rates, high cost or wait till later for high rates, but lower cost.

    Thanks, I can give great advice on art, but I need help with number crunching.

  64. Hi Carl Seattle,
    I’m very novice with Excel and must defer your question to the “Number Crunchers” on this post, Michael and Finance Guy, to answer that question. 😉

  65. David:

    I don’t know your situation so can’t really offer any specific advise on what is very big decision in your life. My general advise is the following:

    1) build thee a spreadsheet model. See my earlier comments on this whole subject. Spreadsheets = free = really eye opening (particularly when one puts in various appreciation assumptions, if any!, and when one compare what a house costs with what a rental costs)

    2) also see my earlier comments on “gurus” — get thee a team of disinterested advisors (disinterested as they aren’t looking to make $ off your purchase).

    3) If buying, I would lean towards “conventionial” financing= 20%+ down, 80% mortgage, fixed rates. There is no free lunch. Every “option” (neg am, option arm, etc) structured in your mortgage comes at a cost. Even a floating rate ARM comes at a cost, eg, you are bearing (unknown) interest rate risk. Just don’t do it. lock in floating rates.

    4) Also, if considering buying, try to come up with your own valuation of a house (based on local comps, your gut feel, whatever). Its perfectly legal and appropriate to submit this offer (most likely a lowball offer!!) to a buyer. Be prepared to walk if buyer won’t budge. Be very very level headed, unemotional, tough, and objective. There is absolutely NO reason to hurry this process.

    Finally, some personal perspective. I have lived in the bay area for some time and the rise in housing prices used to really really bother me, eg, “i’m forever doomed, i’ll never buy a nice house (in spite of my very high income), I hate moving etc” I’m very very much over this at this point. WHy? Moving is not that big a deal — A 2-3 month hassle if that: plenty of rentals that I can afford and local moves aren’t that expensive (say, 2K?).

    Bigger picture: I totally understand your desire to build roots and have a physical achievement and become part of the local community — that all said, i can say that, even without real estate on my personal balance sheet – i’m considered successful (thru my job, thru my work in my neighborhood, and thru my family), I am part of several communities (my particular financial area is very very specialized and we all know each other worldwide, and a large community thru my kid’s exclusive private school), and finally, any fleeting desire i have to, say, “lay down my roots by spending 6-7 figures” is INSTANTLY overcome by my strong desire not to get ripped off and/or lose money on a very big purchase.

    Good luck.

  66. Carl Seattle,

    Your question involves calcualting the net cost of cash flows with different discount rates. You can use the rent vs buy calculator. The calculator takes into account buying a home at different time periods, differnet intererst rates and different prices.

    As Finance_Guy pointed out, surround yourself with a good professional team. Ask your tax strategist/CPA if there is a tax advantage for you. 30% of homeowners do not itemize. If you are one of the 30% there is no tax benefit for owning a home.

    Michael P. Lindekugel
    Financial Analyst
    RE/MAX Commercial
    Team Reba – RE/MAX Metro Realty, Inc

  67. Carl:

    First: Interest rates are NOT NOT NOT determined by compliance costs or the need of stupid lenders to recover their chargeoffs. Interest rates = the cost of money = set by a global daily multi-trillion dollar market that incorporates global inflationary expectations, FX movements, risk aversion, yeild curve mechanics, etc etc etc.

    Second: 5% down tells me you are going to do a piggyback or silent second type mortgage in addition to the first. I’m guessing here but that second/piggyback is going to priced north of 6.2% OR its an option arm or similar lending toxic waste).

    Assuming its a piggy back, and assuming your interest rate on the piggyback is 100 bp (‘basis points’) more than your first, your total monthly payments would be close to 4K a month. Ouch. the total amount of interest you would pay in the first year would be around 33,000. Ouch Ouch.

    Suppose your builder/developer is offering to “buy down” or cap your interest rate during the first few years (say, 1.125% second for 3 years), My calcs still hold. Don’t assume for a moment that these guys can’t figure out to the penny exactly how much this rate buydown is costing them. This is a cost they WILL pass on to you through a higher home price.

    Suppose you are offered an Interest Only or similar product – I would AVOID these at all costs. stroll around the web for a few minutes minute and you will find dozens of horror stories about these products.

    Here is what to do in excel;

    concentrate on these financial functions: PMT (to compute your payments), IPMT (to compute the amount of interest you pay in a given period), and PPMT (to compute the amount of principal you will pay). Note, for a given period, answers from IPMT + PPMT = PMT

    I would build a month by month cashflow, showing exactly how much you are paying in principal and in mortgage interest (which you can use as a tax deduction). If you have an ARM, i would read the proposed financing carefully, and, for starters, assume that your floating rate INCREASES to its maximum amount possible (say increasing 200 bp a year). If you aren’t comfortable bearing interest rate risk like this, don’t get an ARM (!).

  68. Michael:

    My excuse (for concentrating on this blog) is that I am avoiding preparing a presentation I have to give in 9 hours on Implied Vols and something called CDX.NA.IG.

    your excuse?

  69. Using the data for the Seattle metro area, I found that after the market peak in 1980, the 5 year appreciation was just under 2%/yr. Following the market peak in 1990, the 5 year appreciation was a hair under 4%/yr (meanwhile interest rates dropped 40%!!!).

    Whether 7% or 4% (or 2%) is a better estimate for the annual appreciation rate depends largely on whether the market has peaked. Will we see a 40% drop in interest rates (with 30 year fixed mortgages averaging 4.1%)?

  70. I have to agree with finance_guy and others. If I walked into a realtor and he/she told me expect 7% return I would turn around and walk out.

    Now I know that they want their commissions from the sale of homes, but playing ignorant to the housing market falling like a rock is not a smart move. CNN and others and made a foreclosures in the subprime market a near daily news spot.

    Not to mention the days of sub-prime are numbered at the this point. We are going back to the days of 20% down and good credit just to get approved. That and rent-to-own homes. A LOT of people will never be able to buy a home for a few years.

    I think we are moving towards a serious renter society in the US and only the lucky upper middle class and rich class will own the property and rent it to everyone else.

  71. Robert, what part of the country do you live in? Seattle’s home values are healthy and (knock on wood) we have not experienced what other parts of the nation are with home values.

  72. I live in Dayton, Ohio and on a street with 10 foreclosed homes that have been sitting empty for over a year now. Two others are empty and the owners cannot find renters. One is trying to sell. Dayton has been in the news as a foreclosure leader. Cincinnati and Cleveland are worse but I think the state is trying to hide it. Dayton has lost a lot of blue collar jobs in the auto industry and they are blaming that.

    Forget that Bill Gates wants to flood the US with H1-B visa trash from India to ratch down salaries and run people out of IT. That just did the white collar people a real favor. Thanks Bill! I work in IT and I have to operate under the assumption that today could be my last day which is why I’ll never move forward on buying a home. I do not see really anything wrong with renting. Buying and selling a house in a real pain and no one is leaving me any “inheritance”. Why should I leave something for someone else?

    But I digress…

    Don’t worry, you’ll soon see your rash of foreclosures. And if not, you’ll at least see the end of the sub-primers getting homes since sub-prime mortgages will regulated or outright made illegal by the states.

    How dare people with bad credit buy a home. “BAD BAD BAD. Get back in your rent house where you belong you dirty non-rich person, you!”

  73. Oh yeah, something else. Pay attention to the home ownership peddlers here in Ohio. Especially in Cincinnati. They are trying to convince people that the flat tax is a conspiracy to end home ownership in the US!

  74. “Not to mention the days of sub-prime are numbered at the this point. We are going back to the days of 20% down and good credit just to get approved. That and rent-to-own homes. A LOT of people will never be able to buy a home for a few years.”

    We are going back a couple years with financing options, I agree to a point. However, there are still zero down programs and many low down programs that Fannie Mae and Freddie Mac offer as well as FHA and VA.

  75. Something to think about for someone who might want to live more “creatively”: I have been a housesitter for months at a time (making up to $400/week or living for free–simply sitting in someone’s mansion!). I currently rent a room in a comfortable home in a great neighborhood for a mere $450/month. I stash tons of cash into investments/ROTH/savings/CDs. The owner of the house pays tons on remodeling because it was a first-time buyer’s “fixer” (read: “teardown” in Seattle). The house is a money pit—constantly having problems only a year into buying it—but I love living in it knowing that it isn’t my responsibility! I know I’m unique—I live a simple life—but I travel like crazy, have time with friends on the weekends, hike all of the time (no house headaches on a nice Saturday afternoon), eat my expensive organic veggies, and have a sense of freedom that I love! There are many ways to live in this world—and to live happily—being a homeowner is definitely not the only way to do it—especially in Seattle!

    It seems to me that houses have become “baby replacements” for many people in Seattle—that’s all anyone can talk about these days. “What’d you do over the weekend, Joe?” “Oh, I went down to Lowe’s for the 70th time ‘cuz I’m fixing the plumbing in the bathroom”….
    Anyone with a Home Depot card and hammer thinks they’re a Journey level carpenter…..can’t wait to see what all of these $300,000 “fixer-uppers” look like in the future when they’re $500,000. They’ll probably all fall apart because the average schmo is fixing them up 🙂

    And when will everyone stop checking Zillow likes it’s the stock market???!!!

  76. Jojo-great comment! I never thought of that option. How do you find the homes that require “house sitting”? What do you do in between house sitting jobs?

  77. Forget all the numbers. Home ownership, as an owner-occupant, should not be a speculative venture. Sure, we all want a good price, but at what cost? Waiting months? Years? Forget it. I’ll take the 5.75% now and in ten years, as finance_guy suggests, my home will worth what I paid. But who cares? I spent the last 10 years living in my own home.

  78. Matt, I completely agree. There is an emotional value to owning your own home that cannot have a dollar put on it. Not everyone has this value and are perfectly content renting–which is fine for them. I grew up living in rentals, having to move if the landlord decided to raise the rent too much or if they decided to sell the property. Maybe that’s why I have a “need” to own a home. I do not buy homes to “flip”. I anticipate growing roots and staying there.

  79. This is the type of thinking that has a large amount of homeowners on the bubble of foreclosure

  80. My neighbor bought a home two years ago and a couple of days ago he told me that is is losing his home and will face foreclosure because his rates have taken it above what he can now afford, which surprises me because he is a software developer (well over the median here).

    Totally sucks.

  81. Bursting Bubble. My “type” of thinking doesn’t quite compare to what, I think, you are insinuating. I truely don’t give a damn how much my house is worth. I do not take out seconds to fund a consumer lifestyle. I put 20% down last year to get into a jumbo loan at 5.75% fixed for 30 years. I take for granted that I will move away before my 30 years is up, but perhaps not. My parents are in their “starter home” in Irvine, California since 1971. They pledged that they will return home to Hermosa Beach after 5 years. Guess not. They never cared how much their house was worth (over 1mil now) cause they never intend to leave Califoinia since the Real Estate prices are relative. One piece of helpful information to new homebuyers: Fannie Mae offers a 100% 40 Year Fixed Rate mortgage with a 10 year interest only option. If I were to buy now and I had little money, I would go with this. The reason: FULL DOC. Fannie Mae would never lend out to somebody who cannot afford it when they go full documentation. I am not a real estate agent pushing homes in a down market. It just makes sense to me.

  82. Sales in Seattle are all down. Condos are all unsold for over 100 days. Prices have nowhere to go but down. If you don’t know who the suckers are, odds are you are one of them: those who paid higher than average last month.

  83. “I fully expect all of the number-crunching-junkies out there to have a heyday with what I’m about to post…but here goes!”

    Yes. The example works as long as you don’t crunch the numbers.

    Other than the numbers, excellent post!

  84. ps

    It’s fine to own a house: just don’t think of it as an investment vehicle. Housing costs you money: renting a house costs money and renting hundreds of thousands of dollars from the bank costs money. Don’t let yourself believe that you have found the magic bullet that will allow you to live somewhere without paying for it. No matter what a mortgage salesperson tells you.

    If it seems too good to be true, it probably is!

  85. This spring will be very interesting. Inventory high, nation wide house prices are going down, even in Seattle. I bought a home last year and it’s value has gone down 60,000 🙁 I’ll never listen to a real estate agent and should have listened to the economists. I should have waited till now with a larger down payment.

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