Math Monday; the numbers then and now

and therein lies the answer....

"The condo finally cost me $31,600 (AROUND 7.2 TIMES ANNUAL RENT)"

that is where we need prices to return....

Hung -

I think I must have missed his conclusion. I thought he concluded that it was cheaper to own than rent HIS PARTICULAR CONDO by about $50 / month, not including mortgage interest deduction, which would probably be small. What did I miss?

I guess rents need to go lower too???

Shouldn't you also add that, had you held onto that condo, 28 years ago, your 30-year fixed rate mortgage loan would be paid off in two years and you'd be living for "free", whereas if you had continued to rent, you'd be paying now and forever?

you didn't miss anything, we need to revert back to where the rent vs own scenario is almost at equilibrium. As values drop, of course rents will drop as well. Think about it for a moment, why wouldn't they? Owning at one time was absolutely the way to go, now it is not, and it won't be until we revert back to a purchase price of say 100 times rents.

I am a prospective first-time home buyer, and I have followed with great interest recent blogs of this nature, regarding the history and future of the downtown Boston real estate (specifically, condo) market. It strikes me that there are several subtypes of first-time buyers: those that know they will remain in Boston for the long term, and those that, like myself, are young professionals that know they will be in the area for the intermediate term (3-10 years) before moving along to the next job opportunity. Although real estate markets fluctuate locally, there is an expanding sentiment that the national economy is losing steam, and I might argue that no market is immune to a downturn. The Manhattan condo market has already seen the bottom drop out, prices in San Francisco (proper) are down, and I'll argue that the extent that the Boston market changes will be a function of the proportion of buyers this summer that are looking for long-term vs. intermediate term investments.

The annual returns of >4% on real estate, even in historically strong neighborhoods like the South End, cannot possibly continue . . . as a thought experiment to illustrate this point, since this is a worldwide economic downturn, where would the buyers be coming from to push prices up? Consequently, both long-term and intermediate-term buyers must realize there is a strong chance they are buying into a flat, if not declining, market. This minimally impacts long-term buyers, since over the course of 20-30 years, there is a high expectation that their investment will have a positive return. However, intermediate-term buyers have the flexibility of purchasing now [and possibly seeing home prices decline, reach a bottom, and then appreciate over the course of several years], purchasing later [if prices have gone down], or not purchasing at all and simply renting.

An intermediate-term buyer realizes that there are many costs inherent to owning a unit, such as closing costs, condo fees, broker fees upon sale, repairs and renovations, etc. Such a buyer realizes that if a market is expected to be flat-to-negative for 1-2 years, and then flat-to-positive for 1-2 years, he/she may actually lose on their investment, relative to expenditures related to renting. Additionally, with 20% down payment frequently required for the purchase of real estate, these buyers realize that they need to put up a lot of money for the opportunity to expose themselves to, at best, a risky investment in the intermediate term.

My argument is that, unless this prospective buyer sees a screaming deal, he/she will wait on the sidelines. Even with the pending federal tax incentives, current downtown Boston housing prices are so high that the risk exposure to an intermediate-term buyer is too high to buy at these price levels. My prediction is that if the majority of buyers this season are long-term buyers, prices will remain relatively stable in the area. However, if the majority (or even sizable minority) of buyers are able yet unwilling to pay the present prices, prices will trend downwards. This trend will be self-reinforcing, as buyers begin to quote declining prices of 'comparable' sales.

Personally, I plan to wait on the sidelines, with my humble-yet-20% down payment in the bank. If a screaming deal comes along, I will buy, but otherwise I am content to rent. A nest egg in the bank with the potential to yield guaranteed returns in risk-free investments seems much better than the prospect of taking a major hit on my investment or being obligatorily tied down to the Boston area for the long-term.

GH makes a great point, the demand side of the equation (that is buyers qualified to buy) is all but dead. The last seven years of easy credit (like the auto industry) have cannibilized future sales to a large extent. Another issue is Bostonians have yet to see (but will shortly in my opinion) a market of not only excess inventory, but a market of virtually unsaleable inventory. Properties requiring jumbo loans, more challenging underwriting criteria, (especially with an increasing number of weak condo associations),etc.

Is that an accurate value for a condo out in Cleveland Circle? I've seen a few in the 190-200 range (that were in need of major improvements) but I've yet to see one for 165k.

omg. i'm changing my tag from "still waiting" to "buying immediately." was it necessary to take 2 weeks for this lawrence yunian inference that "interest rates are at historic lows and it's the most affordable time to buy in the history of man" to play out? although the feel good story of idiot maverick contrarian does good regardless of market cycle b/c real estate always goes up is good read it's not analogous to current market conditions in any significant relevant way. it was actually almost the antithesis of today.

some observations. first, you bought at a time of insanely high interest rates, from a historical perspective. either they were coming down significantly in the near future or american financial decision making was in the midst of a revolution. short of a deflationary period prices had to go up. rates dropped 5% by '83. not so much today. cost of capital is actively being manipulated to produce tangetial ends, is historically cheap and is unsustainably low.

second, admittedly lazy, i haven't pulled income/price ratios for '81 gb, but i feel it safe to assume that they were closer to equilibrium than today b/c we are just past an unprecedented period where housing prices doubled in 7 years while incomes remained stagnant. if i were a betting man i would bet they were 3 or under and affordable under traditional metrics. unfortunately again we do not find ourselves in such an opportune scenario.

third, the property was greatly undervalued based on the 100-120x annualized rent metric. today the property is almost as significantly overvalued based on the same metric.

the only rub was cash flow affordability, which you actually understated. a side note, i wasn't sure exactly how to reconcile your original premise that you had a contigency to rent for nearly the carrying costs when at best you'd be receiving 83.5% and as noted above, ownership costs were understated. taken at face, if your unit actually was cheaper to own than to rent in today's market it would not be unprecedented but it would be an abberation. i've been doing this analysis on properties that we are targeting for 3 years and have not found 1 that would cost less to own than to rent.

The rent to buy ratio has definitely slipped back towards the landlords/property owners in the stronger rental markets in Boston. But one thing to keep in mind is property values are being propped up by artificially low interest rates. Sam bought his condo when interest rates were high and reaped the reward of falling interest rates years later. Today's low interest rates work against the short-term buyer. I think buying a condo in Boston's stronger rental markets is a reasonable investment at this point, as long as when you decide to move out you are willing and able to do what Sam did and turn it into a rental unit with a positive cash flow. With the prospect of deflation, this may mean paying down a chunk of principal, so I wouldn't buy anything that would keep you from putting a decent amount of cash into savings every month.

"Think about it for a moment, why wouldn't they? " I don't know? Maybe if a lot of people want to rent instead of buying, there would be upward pressure on rentals...until non rentals are full converted to rentals.

I am also curious about another statement in the blog: "Today $2.32 has the same buying power as one dollar did back then." I presume that the inflation that he is referring to includes both housing and other costs. Does that mean that other costs (energy, food, etc) rose at lower than that rate and we should expect them to catch up? Do we expect every sector of the economy to rise in unison? If housing should regress to the mean, should food rise to the mean? Just curious how this works?

You made (if you sell) around $130,000 on a $3,000 investment. Not a bad return, regardless of how you slice and dice the inflation adjustments. (By comparison, $2,000 $ of Zero coupon bond treasuries bought in 1982 at 14% and maturing about now would be worth about $14,000.) The rent during the time period when you bought was not constant (was rising) and may have brought the total income more in line with your ownership costs. Also, the interest rates fell significantly after Reagan was elected and did not remain at 16%; I am sure that you refinanced as they fell.

Hung Wang, has the rent vs own scenario ever been in "equilibrium" in the Greater Boston area in the past 30 years?

They didn't re-mention that the condo they are discussing is a studio. Studios are currently listed around 140K in Cleveland Circle. I would also disagree on the rent. When we move out of our Cleveland Circle studio, we'd like to rent it out, but realistically, 1175 a month would make it one of the most expensive studios for rent. Unless we pour money into it to upgrade the kitchen and bath, we're looking at 1000-1050 a month. That wouldn't quite cover our monthly expenses right now, but we're not moving any time soon.

someone want to save me doing the math and remind me what 120x rent equals in cap rate?

bv - haven't done the numbers, but I'd guess food and utilities as a percentage of income have dropped a lot over the years. Whereas housing as a percentage of income has gone through the roof. That's why housing would regress but not food, because the real underlying driver is incomes.

Yes have been several times where there was equilibrium between owning in renting in Boston, the late 70's and early nineties. I remember being able to buy condos for 15k in Salem, multi- families in Beverly for 50k, where ownership was as cheap if not cheaper than renting. As far as rents dropping, the economy is in for it's toughest ride in a long, long, time aggregate incomes have and will continue to drop, putting pricing pressure on home ownership AND rental rates. People can only pay what they can pay, landlords charging above market/aggressive rents will simply go vacant. The reits are seeing this first hand.

John #3 pointed out that I am now at year 28 of ownership. The mortgage should be close to paid off and cash flow will increase when it is. Unforetunately, I tapped into some of the unit's equity a while ago, which will be discussed in a future blog, but John is reminding us all of why I bought the condo in the first place. Not for appreciation or tax deductions, but to pay it off and then own it outright.
Megan #7 and Cleveland Circle Girl #12- As described in a previous blog in the Monday series, the condo is a studio with a sleeping alcove plus a parking space. It is worth more than a typical studio and less than a one bedroom. The rent is the actual rent that I a now collecting; $1050 plus $125 for parking.
Still Waiting #8 - "was it necessary to take 2 weeks for this lawrence yunian inference that "interest rates are at historic lows and it's the most affordable time to buy in the history of man" to play out?" That may be your conclusion, but my own circumstances dictate what works for me. Keep reading this series and you will see that my philosophy is that buying a home (as opposed to just investing) should be done when warranted by personal circumstances. For the record, I am not a big fan of the NAR, so that was a blow beneath the belt.
"it was actually almost the antithesis of today". You are correct. That is something that I was hoping someone would pick up on. When I bought in '81, the market was almost the mirror image of where it is today.
As for income/price ratios, I have no desire to do that research. Consider that the maximum income/mortgage ratio then was 28%. In the last 7 years, I have seen that ratio as high as 52%. Now it's back down to around 30%. That, along with the return to stricter credit guidelines has cut out many potential buyers that would be putting themselves and lenders at risk if they borrowed. That is why home prices are moderating.
To everyone else- thanks for taking part in a spirited conversation with lots of great observations. Here is a concluding thought about the condo; it is a hybrid by design because the original one room studio design now includes a sleeping space, so it is somewhere between a studio and a one bedroom. As a result, it commands higher rent and a price toward the high end of the range for its size. Watch for that theme again as we discuss other properties later in this series.