Big detail missing here: a standard mortgage is the only way for the average person to make an investment with 5x (or more) in leverage. For a 20% down payment, you effectively get to invest 5x your money into a real estate investment of your choice. The real estate market as a whole is certainly less value-producing than something like tech or chemicals, but Joe Salaried can't easily go out and ask his 401(k) plan to leverage him out at 5x his net worth.
It's not for everyone, and it's certainly a risk (like all leveraged investments), but it does provide an opportunity that very few other common financial instruments provide.
Why would you want to leverage up an investment whose expected returns are barely above inflation, though? It's a fairly good bet that the appreciation on your home will be less than the interest you're paying on your mortgage, which makes this a net loss. (Particularly now, right after home prices have seen the most spectacular run-up and bubble in nearly a century.)
You'd do it because you expect that the return on this particular property at this particular time will be significantly above inflation.
I think this would be a reasonable bet in cities which have had particularly strong post-bubble deflation but which nonetheless have strong long-term growth prospects. If I had lots of spare money I think I'd be buying up five-figure houses in suburban Sacramento right now.
It's not just growth prospects, you're making a bet on the regulatory environment continuing to restrict the supply of homes. It may seem like California will never open up more land for housing, but it's not a law of nature.
Just a guess based on the vibe of the place -- it feels like a city which is going to continue to grow in population and importance, and it's come down a helluva long way since the peak of the boom. I could be wrong. If I had a really good reason for believing it then I'd be out there buying instead of talking about buying.
I'm only picking on Sacramento because I used to live there, there could be much better buying opportunities in cities I don't know so well.
It is possible that it will rise, but it seems to lack the NY/SF factors of limited supply (land) driving prices through the roof. In SF, there is only so much space, so the affluent can keep driving prices higher. Around Sac, there is plenty of farmland ripe for development.
(example: Austin, TX is a great place to live overall, but it remains cheap due to "endless" land).
Why on earth should the average person make an investment with significant leverage? The only reason, ever, to make an investment with leverage is if there is some arbitrage opportunity that requires a large amount of capital to make money from. But by definition, the average person is not going to be able to identify arbitrage opportunities in the housing market.
The real reasons to invest in housing are: a) diversification (so not everything is in bonds or stocks) b) excellent tax treatment c) excellent political protection d) interest rates that are often lower than the monetary inflation rate (by monetary inflation rate I mean growth in M*V - nominal income growth). However, at this point, all the above factors are already capitalized into the price of housing. So at this point there is not much of an economic benefit to buying housing.
The "average person" quite possibly thinks he/she is above average in terms of identifying such opportunities (cf. Lake Wobegon effect).
On top of that, there are government initiatives to "encourage home ownership" and to protect "homeowners" even if they bet completely wrong or obtained loans they couldn't possibly have qualified for if the lender had any common sense. These will tip the balance in favor of going into the housing market.
It's becoming a bit easier for the retail investor to do other kinds of leveraged investments, since a lot are now packaged up into ETFs. For example, NYSE:ROM is a 2x-leveraged basket of technology stocks, and NYSE:TNA is a 3x-leveraged derivative of the Russell 2000 small-cap index. Of course, these are not necessarily a better idea than buying a house.
Leveraged ETFs seek to provide the expected return on a daily basis. They do not provide the returns that you might expect over periods longer than a day, and therefore are only useful for day traders.
+1 for correctly stating how those investment vehicles are structured. In fact, expect not to see them much later in the future as people didn't understand how or why they performed as they did.
These ETFs you talk about are usually leveraged through some combination of options which means they have significant time-value decay, making them an unsuitable long-term investment.
Every now and then I see articles like these. It always seems to me that the author is simply trying to justify the fact that they rent. Renting vs. buying is a very personal decision and has a lot more to do with lifestyle and personal choices than financial soundness. I bought my house in 2005 at almost the top of housing market in Florida. I paid $145k for my house and told everyone about how smart of a financial decision I was making. I've spent $15k in home improvements and my house is now worth $125k. Oops. However, my mortgage is still very low and I can easily afford it regardless of the current worth.
Now the question is, if I could see the future back in 2005, would I still buy this house? If all I could see was the housing crash of 2008-2009, then of course not. But if I could see the great times I've had in this house which includes absolute peace and quiet, friendly neighbors who don't change every other month, and the feeling of a little place by the beach to call my own, I would indeed buy this house. Buying a house has a lot more to do with making it a home than just a shelter for cheap.
Nobody knows the future. I could have rented this exact house and instead of benefiting in the long run, I could have ended up losing more money if rent prices skyrocketed. All I know is that for people who can afford to buy and afford to rent, money has very little to do with buying vs. renting.
Renting vs. buying is a very personal decision and has a lot more to do with lifestyle and personal choices than financial soundness. Says someone that bought a home.
I want to walk to work and there are no homes for sale in my area. So even if I make 500k / year home ownership would still bring significant negative for my lifestyle. When you consider commuting costs, home ownership is both risky and far more expensive for most young people.
I said walking to work that's not exactly a huge area. Now 2 miles from me there are homes for sale, but driving that distance and parking in a parking garage is far more time consuming than walking. Taking a bike could also be an option.
It's a lifestyle thing, I can walk home for lunch watch something on Hulu / DVR and then go back to work all within my lunch hour. It might not seem like it but there really is a difference between a 3 minute commute and a 15 minute one.
PS: Walking 2+ miles in my area is slower than than driving that far and all I really care about is the time.
Well, you are talking about $145k, in Bay Area or in Seattle, for example, you can't buy any house at all for this price. Would you still buy this house if it would cost you 600k?
Exactly. It seems to me that the only people who really need to worry about the economics of renting vs buying are those for whom houses are very expensive; either because they live in an expensive area or because they have low incomes. If you can buy all the house you need for $150K and you're earning at least, say, $50K then by all means go ahead and buy a house for the lifestyle reasons. But if the house you need costs ten times your annual salary then you need to think a lot more carefully.
> All I know is that for people who can afford to buy and afford to rent, money has very little to do with buying vs. renting.
If I could afford to buy a $600k house and afford to rent a similar house in the same location, whether I buy or not would depend on my personal choice (which is to buy, not rent). If I can't afford to buy, then why even get into a debate. Of course I will rent.
re: "It always seems to me that the author is simply trying to justify the fact that they rent." - this always seems to be the case. The few renters who seem to do well financially would also do well financially as homeowners but for some reason have convinced themselves that the numbers work out better for renting. Maybe it does for those people, maybe it doesn't. I'll come back to that point in the next paragraph. In the meantime, however, the vast majority of renters one might speak to are just pissing away money, are no further in terms of savings than those with mortgages, and have none of the equity built up that those with mortgages have, even those who are pretty new to their mortgages.
Now, back to whether or not those "smart" renters are any better off. First off, I'll readily admit that my single data point is just that, but it bears consideration nonetheless. I bought property in 2005. In a neighbourhood with some growth potential, in an overall market with generally upward movement. Nothing bullish, just generally upward movement. In fact, that movement had been slowing a bit at that point, and continued to slow somewhat more afterwards. We all know what happened next. I sold early this year. I wonder how many smart renters could have done this _well_, even given the shitty few years I happened to own before selling: I paid $500 more per month than what I would have paid to rent the same space (in other words, put me up against a smart renter with $500 to invest each month), for a total of $30,000 "invested" progressively over those five years. I sold for a net profit of $125,000 after all fees, commissions, etc. In a hesitant market still recovering from the nasty troubles we all know too well.
Find me a renter with that kind of ROI on their investments over the last 5 years and I'll congratulate them over a nice lunch which I'll be happy to buy for them.
"Find me a renter with that kind of ROI on their investments over the last 5 years" is asking the wrong question.
While it's true that there are wins to be made in real estate (and I congratulate you on your successful outcome), there are also losses. Not only did you pay $500 more a month, you took a risk (the degree of which depends on your circumstances) that the home would rise in value. Had it not done so, you'd be stuck paying $500 more a month in addition to other potentially large losses.
Renting is (generally) lower cost, lower risk, lower potential ROI. Buying is (generally) higher cost, higher risk, higher potential ROI.
> I sold for a net profit of $125,000 after all fees, commissions, etc.
Where does that "value" come from? The entire real estate market is built on the premise of property valuation continuously raising - causing and eventually surpassing inflation. This is without even accounting for the actual exploitation/gaming of the system.
Everyone has already forgotten, or chosen not to think about it in favour of short-term gain.
If I were lucky or if I had made any effort whatsoever to time the market, you might be right. On the other hand, I know of lots of data points like mine, even with the crapfest of the last couple of years. (Sensationalist news articles and statistics about idiots lending too much money to other idiots really shouldn't hold much water to the HN audience, if you think about it.) Regardless, find me that renter and I'll buy them a nice lunch. If I could have made $125,000 during those years then by their own arguments all of these "smart" renters should have been able to do the same through some alternate portfolio of their choice.
As an aside, am I the only person to notice that every time a renter posts these kinds of articles they always talk about how down the road they'll have enough money to buy a mortgage-payer's home but they never actually bother to mention how their investments have been doing for them in the meantime? I suspect there's an obvious reason for the omission.
What we see here is that, aside from some interesting but minor fluctuations and a scary but temporary blip representing last decade's bubble, housing prices are almost flat in real terms: The increase in median house price is almost equal to the inflation rate. Meanwhile, stock market investment values fluctuate a lot -- the last decade was not especially kind to investors -- but over the 1950-2008 time period the market averaged nearly 7% over inflation if you reinvest all dividends.
Now, you can get lucky. Or you can leverage insider knowledge: If you figure out that land in a certain area is systematically underpriced relative to future demand, you can make a killing without relying solely on luck. But the averages show that for every person who makes a killing in residential real estate, there's someone else who takes the equivalent bath. And note that the argument that "land in NYC/Northern California/Desirable Area X will keep growing in value because everyone wants to live there" presumes that the rest of the market hasn't already figured out that such land is more desirable and set prices accordingly.
For the record, I'm not unhappy at all, and if you'll look back at my original reply I was very up front about being just one data point.
You can get lucky. Or you can leverage insider knowledge. Or you can do some personal learning and invest wisely. All of these are equally applicable to investing in real estate or to investing in other things while being a renter. For some reason, however, those who profit from real estate are chalked up as lucky and those who profit from other things while renting seem to get to talk as if their success involved any less luck or any more informed investing. Why is this? In my case, I invested in a physical market in a particular region I had been watching for many years and which has generally steady indicators. I exited for entirely personal reasons (to live with my girlfriend, just to put it out there), not to "time" the market as claimed by one commenter who also claimed I got lucky. I was subsequently called out as unhappy by another - you. Again, why is this?
Any argument that can be made for or against success by an owner can be made equally well for or against success by a renter investing elsewhere, yet luck only gets cast towards the former, wisdom only towards the latter, and all the while the latter never seem to publish any of their investment success numbers to match their claims of benefit down the road. Again, why the disparity?
Whether in real estate or elsewhere, it's the same $500 per month during the same five years. Whether sourced from luck and/or expertise, why are one class of returns immediately disparaged while another goes entirely unstated yet entirely uncontested? I've never taken it as an offense personally, but do admit that it does seem to be a common pattern and not a particularly fair pattern, at that.
I've been debating whether to buy for about a year now, and you make an excellent point. For me, it boils down to the choice between a sense of freedom and a sense of home.
(Speaking from the Australian market, so there might be a few things that make the situation different for you.)
If you want to make major improvements or tweak your home, then home ownership beats renting. If you don't plan to live somewhere for more than five years (and transactional costs in buying and selling are harsh, as in South Australia), then renting could be your best option. If you lack financial discipline, then buying can beat a combination of renting and investing in shares.
Of course, you can always buy one place, rent it out and then rent another place yourself.
There is absolutely no reason to believe that countries with high levels of homeownership, like the U.S., have better economies than those with low levels of homeownership, like Germany.
And yet the US has a higher per-capita GDP than Germany, right?
Besides, homes have to be owned by somebody. If homes aren't tying up the wealth of Joe Workingclass they'll be tying up the wealth of John Richbastard instead.
How much of the low rate of home ownership in Europe can be attributed to property title? If the only housing units available are blocks of apartments on a single deed then you'd expect a low rate of ownership, whereas if the entire country was split into individual-title houses then you'd expect a much higher rate.
EDIT: Wait, I forgot to mention the screwiest thing about the long-term prospects of Germany: it has a birth rate of 1.4 per couple, way below replacement rate. I'm guessing that this could have a lot to do with the housing supply being concentrated towards small apartments and away from large houses.
The US does have a higher per-capita gdp (probably; the numbers are subject to a lot of interpretation) but that is in no small part due to the fact that the rest of the industrialized word was mostly leveled in WWII. As of recently, I believe West Europe's gdp growth numbers are comparable to or exceed those of the US. But again, the devil is in the details in these things.
As for birth rates, well... that's a pretty wild speculation. Demographers have a decent handle, as far as I know, on the causes of low birth rates. Do note that America has a declining population ex immigration, and that the birth rate for white people is below replacement rate and has been for 30 years.
Given a market that is in any way sensible, shouldn't buying wind up cheaper than renting over the long run? Landlords don't buy investment property out of the goodness of their heart, they buy investment property because they think that the money they make in rent, plus the capital gain on the property, minus the various maintenance costs etc, should be sufficient to compensate them for tying up hundreds of thousands of dollars in the asset.
Not necessarily, because there are some effective costs that a homeowner pays that a landlord does not. First, the loss of the ability to move easily. Second, the landlord probably has economies of scale on things like time and money spent on maintenance.
Who says the market is sensible? There's a lot of noise out there. Someone buying property not only has to guess that an area will go up in value, but they also have to factor in:
1) inflation rates (higher inflation is much better)
2) tax changes (e.g. the passage of prop 13 in California helped investment property owners greatly)
Well I'd never say the market was sensible at any given place and time, but I think it tends to fluctuate back and forth somewhere around the vicinity of "sensible". If you decide that renting is going to be cheaper than buying for the rest of your life then you're gambling on the assumption that the market stays on one particular side of "sensible" for decades.
How's that? Sell house, sign lease, you're done. Only a problem if you're underwater and I'd strongly advise against buying for anyone in a position where winding up underwater is a strong possibility (ie anyone with less than, say, a 20% deposit).
I tend to agree with the article - especially in California it makes no sense to own a home at current prices, rent is a great deal and most landlords with a mortgage have negative cash flow.
In some other markets, like Texas, it's possible to own rental real estate that cash flows.
So this is the strange position I'm in where I own houses to rent but rent the place I live.
Takes into account variables such as monthly rent, house price, down payment, property taxes.... and it has a sweet graph that shows over time where you are financially better off renting or buying. Pretty cool.
Great for anyone who is between two minds about what to do, or is considering investing into a depressed market.
> your landlord/agent has the right to enter your house for an inspection
You should demand that your rental agreement stipulates that your landlord must give at least 24 hours notice before entering your home. This is pretty standard, but in cases where it's not yet in the contract make sure to have it added.
> and they can sell or occupy it, requiring you to move
Depends where you live. In California (at least in SF and LA; don't know about elsewhere), landlords can only do this if they or a family member will be moving in. In SF in particular tenant rights are strong and it's practically impossible to evict tenants.
Though in my opinion they go too far there; non-paying tenants can linger for months, and creepy d-bags who sexually harass other tenants can't be kicked out even if the landlord and everyone in the building wants them gone (true story).
"You should demand that your rental agreement stipulates that your landlord must give at least 24 hours notice before entering your home. This is pretty standard, but in cases where it's not yet in the contract make sure to have it added."
Depending on what state you live in, that doesn't have to be part of the rental agreement--it's part of the law. I believe that's part of the right to "quiet enjoyment".
It's probably always a good idea to study up on your rights as a tenant in the state and city you live. That ought to be a factor in the buy vs. rent decision.
In the limit, that's like buying the house with cash up front, which amounts to betting that the appreciation will exceed any investment income. For example, given person A who paid cash for a house a year ago and person B who put that money into an index fund, in most parts of the country B would be much better off right now.
The mortgage is structured for a given term. If you pay off a 30 year mortgage in 2 years, you're still paying 30 years worth of interest. There's no gain, in fact, you lose because you lose the time value of money.
Paying straight cash for a house, or buying a house on a small fixed interest and a short term already baked into the mortgage, can gain you something. Paying off an existing mortgage early gains you time and the psychological benefits of not worrying about making the mortgage next month. If you're about to die, it lets your descendants take their time selling the house if they can't afford to make the payments.
That is not true. Well, it might be in some specific cases but in the UK at least it's perfectly normal for a lender to impose no penalties for early- or over-payment. Our mortgage market is extremely competitive however (that amplified the effect of the housing bubble).
Mortgages vary, but it's been known to happen It's not a penalty per se, it's just that if you pay twice as much as your next monthly payment, all you gain is an extra month before your next payment is due. It's not a free-floating line of credit--it's an agreement that you will pay this amount per month for 30 years, and there are no discounts for going faster than the schedule requires.
Think of it in this way: as an investment, I'm making a secured loan to you from which I am expecting a given return over the next 30 years. If you're excited to pay me off in 5 years instead of 30, maybe we can make a deal (quite often there's refinancing involved in that arrangement) but I got into this deal expecting 30 years, not 5 years, of interest at that rate, and you agreed to that, too.
Do you actually have (or have you read the terms on) such a mortgage?
Any additional amount I send in on mine is credited as "additional principal payment" and reduces the amount owed (and hence the interest). If I had <mumble> thousand dollars in hand, I could pay my mortgage off Monday without any penalty, just five MONTHS into my refinance.
I have seen no-refinance-before-such-date mortgages, and while it's possible that a mortgage with a prepayment of additional principal penalty or barring exists, it's certainly not common in the US.
Not sure where you live, Phil, but that's absolutely not the way mortgages are structured by national banks in the US.
In the early years of a mortgage, the buyer is gaining the leverage of a large amount of the bank's money, so a huge percentage of his payment goes to interest on the loan. In the later years, when the remaining principal is smaller, he pays less interest. The buyer's total payment is the same amount over the term of the loan, but the portion allocated to principal vs interest varies linearly over time, til remaining principal == 0.
At any time, the buyer can pay off the note by delivering the currently-remaining principal to the lender.
The schedule you describe would effectively prevent anyone from ever moving before their mortgage was mostly-completely satisfied. If you bought a $200K house and sold it a day later, you would have to send the bank a check for about $600K. I'm pretty sure this never happens.
Furthermore, the lender is always making his margins (modulo interest rate variability, and ignoring loan quality), because any payments sent to the lender by the borrower will get re-loaned to someone else. I guess you could write a contract so that the borrower would be penalized if he paid off early, but I'm not sure it wouldn't be usury.
Note that if you double a mortgage payment, you should be explicit that you want the excess applied to your remaining principal. Otherwise, the bank can choose to apply it as "the next payment" and therefore split at your current ratio. Regardless, you still have to pay next month's bill too. :)
Certainly a mortgage like that would be a very hard sell in the UK. As in, you'd probably have to offer it only to risky customers. My mortgage provider gives me a choice if I overpay a lump sum: I can reduce the term and pay the same monthly, or reduce the monthly payment and keep the term.
It's a simple calculation really, how many customers will actually pay off their mortgages early vs how many customers you will attract by offering the option to do so.
I'm not a homeowner, but I believe most mortgages are
"frontloaded", at least to some extent, so you're paying off the interest before you pay off the principle.
Its not uncommmon to pay ~2x the principal in interest. So I couldn't say for sure, but I don't see it having a huge impact.
Mortgage payments are usually calculated to be equal over time. Therefore, a greater proportion of the early payments goes to interest, but a greater proportion of the later payments goes to principal. Payments in excess of the set payment amount are generally applied to the principal. Thus, making payments in excess of the set payment amount early in the life of the loan will reduce the principal faster than expected, and the total interest paid for the loan will be reduced.
My experience may be useful only for sf, but I live in the city in a nice (by my definition of nice: 100+ years old, solid wood floors, plaster walls, detailed woodwork, thick aged wooden doors, handmade ironwork) apartment. My landlord would like to sell the place to us, but our rent doesn't even cover the mortgage with a $100K downpayment. By the time you add HOA fees, insurance, taxes, and a 3-5% of value annual maintenance investment, my landlord pays me some $800-$1000/month to live in his apartment. Which is fine by me.
It may be cheaper for your landlord to pay all that than it would be for you to do so, though, so he might not be losing that much. In particular, if he bought in a while ago, he probably pays much less than the official rate for property taxes, due to Prop 13 grandfathering in an anciently low valuation.
Insofar as negative gearing is a good thing, it's not a good thing for renters.
Investors need to be losing money for negative gearing to do them any good, and it won't magically turn that investment into something profitable.
It is helpful if they're speculating on a big capital gain. In fact that's one of the recurring criticisms of negative gearing - that it encourages speculation and inflates property prices, neither of which are good things for renters.
People have, inevitably, used it to engage in various tax-reduction schemes, with varying degrees of succes (see the 2004 Australian High Court case of Hart v Commissioner of Taxation for an example of that _not_ working out). This is not a good thing for renters either.
From your description, you qualify for rent control, which means your landlord can only raise you rent at the rate of inflation (with certain exceptions).
San Francisco's rent control law covers most rental property in San Francisco. If you live in San Francisco, you are covered by rent control unless you fall into one of these major exceptions
1. You live in a building constructed after June of 1979. This "new construction exemption" is the biggest exemption in SF
2. You live in subsidized housing, such as HUD housing projects.
3. You live in a dormitory, monastery, nunnery, etc.
4. You live in a residential hotel and have less than 28 days of continuous tenancy.
It's not for everyone, and it's certainly a risk (like all leveraged investments), but it does provide an opportunity that very few other common financial instruments provide.