Its funny how these things run: there are days when the NYT puts me to sleep, and there are other days when I cannot get enough.
Today was the latter: The NYT’s biz section is an embarassment of riches:
• The above the fold Biz section cover story — Some New Math on Homes by DAMON DARLIN — has that uh-oh quality about it: New math rationalizes away fast rising prices (sounds vaguely familiar);
• Joe Nocera takes 60 Minutes to task in Selling Short the Virtues of Short Sellers;
• CONRAD De AENLLE defends Technical Analysis and technicians as "providing a reality check to conventional thinking;"
• Jeff Leeds on how the Music Industry Posted Their Sixth Year of Decline (What a surprise!);
• The terrific FLOYD NORRIS observes that China and U.S. are the World’s Growth Engines (but their Markets are Laggards);
• Real Estate writer (and Walk-through blogger) DAMON DARLIN shows how to Calculate what to Pay for a Home;
All very much worth reading . . .
“They argued that the value of a home is determined by the rent it could fetch. Calculate the future rents, subtract mortgage payments, taxes and other costs, factor in a good annual rate of return of 6 percent or more, and one should be looking at the proper price of a house or condo.”
“Their bottom line was: “Buying a house at current market prices still appears to be an attractive long-term investment.”
———-
Is this not completely circular reasoning?
The same phenomenon that fuels the housing bubble, er, souffle has also fueled the appreciation of rents. Historically low interest rates and aggressive mortgage lenders expanded the pool of buyers dramatically, as did the perception that housing prices will continue rising or flatline at worst.
When long term rates go up enough and the easy-credit taps get shut off, the pool of buyers will shrink dramatically, neighborhoods everywhere will turn into “no-bid” situations as buyers wait out unrealistic sellers, and rents will fall sharply as landlords feel the pinch of the monthly mortgage nut.
What these professors have done is taken an unsustainable present day situation and extrapolated it into the distant future. They assume that real estate is still a good buy because rents are high, without recognizing that both variables (the price of houses and the price of rent) actually hinge on a third variable: the perpetual availability of easy credit via low long term interest rates.
What is it with economists who have no ability to see around corners, or even to imagine that corners exist. Everything is a straight line to them. This is the kind of intentionally myopic thinking that is responsible for DCF analysis in a vacuum, trying to argue why Buggy Whip Incorporated will still be profitable twenty years down the road.
Good comments, trader75
This weekend my Mom called me and said, “I think we should try and get into the real-estate business… what do you think? Start our own business or something.” For a reference point, my Mom bought a basket of Internet stocks in January 2000.
I’ve been thinking of buying a mansion on the lakefront and splitting it in 2.
These homes already have a gardener’s house (larger than 1800 square feet) so one set of parents could live in it and the other in the other half of the home.
Apparently, new zoning laws are permitting houses be converted into multi generational homes.
My intuition tells me that when boomers realize they don’t have enough money to retire, many large homes will be converted into duplexes, triplexes or multigenerational homes.
Suddenly we’ll end up with way too many houses on the market! In such a case, rents would drop and so would home prices!
Remind me not to send my kids to Claremont College to get an economics degree. Wow.
First of all, everything he says is based on a “assumed” 6% appreciation rate….I guess cuz “real estate always goes up.”
Once you have those assumptions in place, it’s pretty dang easy to calculate ever higher real estate prices. Of course, you could have made the same case in 1989 in SoCal for buying a home. Only you’d have been terribly wrong, especially if you bought in 1989-1990 and had to sell prior to 2002.
In the example Smith cites in the article, he claims a home that has a rent equivalency of $2,295 could be bought today for up to $696,000 and the buyer would be just fine and dandy….assuming that “magic” 6% rate of return.
When you factor in everything Smith does, you come up with a monthly gross payment of $6,154 to own vs. $2,295 to rent. Factoring in full deductibility and principal amortization, you get a net figure of $4,877—or $2,582 more per month to own vs. rent.
And that’s “assuming” a 5.7% mortgage, a very modest amount for maintenance/repair/upkeep, and an assumption of 3% annual rent increases. He also neglects to mention the opportunity cost of the 20% down payment of $139,000. At today’s risk-free rate of 4.5%+, that represents an income loss of $521 a month right there.
He also “assumes” the tax deductibility of mortgage interest, which as we all know is a pretty big assumption for many folks.
Net/net, Smith is telling buyers not to worry about spending 112% more to own than to rent the equivalent home, since appreciation will make up the difference.
I suppose if you plan to own the home for 15/20/30 years, he may have a point. Maybe. But given that the avg holding period for a home in Calif these days is 5-7 years, that’s yet another mighty big assumption.
In short, this is crap economics. He’s assuming all the positives will occur and assuming none of the negatives will occur. At current prices, that’s a lot of wishin’ and hopin’.
My grade: D-.
The problem with the NYT — no page 6. Give me the NYP anytime.
Appropriate for an April Fools issue!
Appropriate for an April Fools issue! – New Math on Homes Article I am refering too