Emotion Distorts Logic

[bsrsharma]

stan,

upload to a website and post the link.

[justdoitstewart]

I agree with your logic, but did you factor in the shortage of future buyers there will be with the new (old school) underwriting standards? (i.e, 10-20% down payment, appropriate income and good credit score)

(response to sdsundevil)

[bsrsharma]

I took a cue from my POT smoking … who sold his house to a drug dealer, so I sold my house for over 700K to a …

There will be lot of juicy paperbacks in 20 years about these times.

 

[stansd]

Holy Crap!

I’d never quite looked at it like this. I modeled what it would take economically for a $600K house in 4S to be equivalent to rent or buy. Obviously there are a host of assumptions inherent in any kind of analysis like this. One key one I made is that the housing market would be flat for the foreseeable future.

If that were the case, a $600K house in 4S that currently would rent for $2,300/month would have to fall to $310K for buying and renting to be equivalent. If you move assumptions a bit and assume a 3% annual appreciation rate, that number goes up to $626K. Regardless, the mello-roos there is an absolute killer to the equation.

Bottom line is that it’s all very dependent on what you think will happen to appreciation/depreciation.

There are some simplifications in the model that if fleshed out would change the picture a bit. Regardless, given the current situation in the market, that $310K figure surprised me. Tells me that you could easily make the case that a $150K drop in 4S is very possible.

Here is the link to the file I used (excell 2007, so hopefully it’s openable):

http://www.swoopshare.com/file/7f07d88ac69f4d03b5ec60a0bf6c014a/Housing_Cost_Model.xls.html

Stan

[Bugs]

The Mellos Roos is what prevents that $600k home from being a $700k home. These developers aren’t selling a sale price, they’re selling a payment.

[rseiser]

Stan,
I looked at your Excel file and it is very nicely made. You are pretty close to a good price/rent estimate when you assumed 0% appreciation.
You say that “it’s all very dependent on what you think will happen to appreciation/depreciation.” Yes, but not as much as your model shows. In your model, a change from 0% to 3% doubles the price what you can pay to be even with rent. This is too much. You got that large of an effect because you added the Equity Generated and Equity Appreciation/Depreciation as a monthly income. This is not correct since it is not a cash-flow. It is a future realization of a gain and has to be adjusted for net-present value (or opportunity cost if you will call it that way).

I think a 4%-7% appreciation (=inflation) would be fair to assume from the point in time when mortgage equals rent.
If you change your spreadsheet to account properly for the opportunity cost of the paid principal, you will see that even a slight appreciation does not impact your price that much.

I am not sure what the 100% correct way is to do that, but you can try it with assuming that you take an interest only loan. (or even a neg-am loan with going negative by the amount of yearly appreciation). Then you never own the house (but do get a monthly appreciation discount), and that should be equal to renting. You will again see that a $1,000,000 home equals about $6,600 monthly rent. This is the rule of thumb I always use.

So let me know with what updated spreadsheet you come up with.

[Anonymous]

I notice that everyone’s calculations assume a 6.5% interest rate – I don’t think, as prices fall and lending standards tighten, that assumption can be made. Interest rates were anywhere from 8 – 13 % in the 80’s, why can’t they be at that level again? That would mean that the payment on any given principal would be higher, thereby driving the rent vs. buy ratio further towards rent, no?

[rseiser]

Higher interest rates won’t change the calculation that much, since the expected appreciation (inflation) might also move in lockstep. I don’t think a 13% interest rate and 10% inflation is much different than a 6% interest and 3% inflation as far as the fair assessment of rent vs. buy. And probably, medium-term interest rates will be somewhat above medium-term inflation, as far as the latter can be forecast right.
I don’t see any cases where you would be completely off with your estimate.
Maybe in 1980 if you took a long-term loan at 17% and inflation dropped thereafter by 5-10%. But so did interest rates, and you could refinance.
Or maybe when recently the 10-year was at 3.5%, you might have a hard time guessing inflation. It probably wasn’t 1% but rather 5%. So you could have paid slightly more for a house, but there probably wasn’t one close to that price anyways.

So these rent vs. buy calculations are probably a good guide. I emphasize “guide”, because ultimately history might be more accurate. If history shows that mortgage/rent was typically between 0.9 and 1.3, any calculation won’t change the fact that 0.9 was a good deal, and 1.3 wasn’t.

[want a good deal]

Dont know how much this pertains to the conversation but I read in the UT that only 9% of SD County residents make over 75k a year. Even if a lot are 2 income households it seems like thats hard to pay a mortgage on a million $ home. It was a good article talking about the hourglass shape of incomes in the county. The upper incomes are increasing and the lower are too but the middle incomes are stagnant. Good solid middle income jobs are being replaced by lower paying tourism jobs and high paying execs are coming here. Also on the high end education and healthcare is doing well. I had to go to three breakfast joints this morning to find one without a 30 minute wait. People definately are not eating at home. I eat out at least 8 times a week and the restaurant business is good. At least the middle of the road type places. Only eat real high end once a week and they are hit and miss as far as business goes.

[mixxalot]

Consumer waste and disposable income.

I went to Fashion Valley mall today and walked around and noticed the ladies with all the overpriced purchases from Neiman Marcus and whatnot.

Whats funny is how few Americans even cook meals anymore. There was a mile long line at PF Changs and Cheesecake Factory- both chain restaurants that server average food at ripoff prices.

Not only hours of waiting to eat, I would prefer to save my cash and not have to wait and fire up the grill like I did today when I got home and grilled some steaks. Cheaper than these chains healthier and tastier and NO WAIT!

[bsrsharma]

mixxalot – want an example of misplaced sense of priorities? Read this tragic story below. This woman can’t cremate her mother, but has money for toys.
———————————————————–
Comment by walt526
2007-09-03 13:16:54

Last week, a co-worker’s mother passed away. The co-worker is a single mom (13 year-old daughter and 4 year-old son) who had been living in a two-bedroom apartment with her mother (until she died). Her mother’s social security disability check basically covered their rent, while her paycheck covered everything else. So now she doesn’t know how she’s going to cover her September rent and can’t even come up with $600 to cremate her mother. She was overwhelmed with not only losing her mother, but was completely screwed financially.

This woman is a good friend at work, so I talked about it with my wife and we decided to give her a check for $300. So on Friday night, we headed over there to meet her at her apartment. We go inside and sit down and the 4 year-old starts showing us how to work the Comcast digital box. Then my co-worker asks me if we’d like to watch last week’s episode of Big Love on HBO On-Demand. She knows that my wife and I really like the show but only get to watch it when we’re over at my parents. We just subscribe basic cable because of the cost, even though we’re DINKs who gross a combined $90k.

I didn’t say anything, but that really pissed me off. The woman makes ~$35k with two kids, and she’s spending $100/month on Comcast? I also know that she has DSL plus a cell-phone for both herself and her 13 year-old daughter. So she’s probably spending around $200/month on telecommunications.

As I said to my wife once we were inside our car, that $300 isn’t paying to cremate her mother, but is paying for 3 months worth of cable. This country is doomed because nearly EVERYBODY confuses luxuries with necessities.

$600 is not that much money. Granted, it was an unexpected expense, but shit happens. You’ve got to be prepared. Next month it could be the timing belt on her van or something with her kid, etc. That’s why prudent people don’t spend everything they earn. Now I’m glad that we were able to help her out, but I just feel that she needs a serious reality check about how she spends her money.
———————————————————–

[mixxalot]

Misplaced priorities and 0 savings a big flaw in America

BSR- great story and sad reality in America.

Heck I dont even own a TV anymore just a laptop for work and do a lot of fitness and reading as hobbies they are healthy and low cost. Investing is another hobby that I am learning. Currently reading about asset allocation strategies.

I could buy now but would not be foolish to throw away money knowing the market will tank in San Diego. The savings would easily fund a new sports car, home tv theater, trip to europe and index funds with cash left over for the wait.

But I do realize that I am in the minority in America.

[stansd]

Thanks for the feedback, Reiser…I’ve known for awhile that the way I was capturing appreciation/depreciation wasn’t quite right (one of the things I had in mind on the simplifying assumption comment). I’ve been struggling with a way to characterize that correctly. You’ve given me a few ideas on how to mull that one.

I think the 0% gain assumption effectively assumes housing appreciation=inflaction. Anything more is gain. I might think about taking that number and discounting it back to present value over 5-7 years using the interest rate on the mortgage…far from perfect, but that would mute the impact some, which I agree needs to be done given the cash flow considerations.

No time to mess with it right now (spreadsheets to work on for my real job:), but I’ll have to take a stab…that sheet has been a continual work in progress, but it’s really helped me to think about things.

Stan

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