Rational Home Buying
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The house was 3x our annual income (well, 2.5).
We can probably rent it for our mortgage. (This for me is the most important thing -- basically we bought the rental we would have lived in).
My job is moderately safe.
We don't expect to sell for 5 years (which is the conventional wisdom unless you are a professional and know what you are doing).
I hated our last four landlords.
We have to live somewhere.
No kids, so no worries about kid like things except in terms of n-hood value.
I just wanted to weigh in and say how huge this is, not just for the question of "is buying a better deal than renting," but also to allow you flexibility in terms of job relocation and family changes.
My girlfriend and I moved to the Bay Area about 18 months after buying our first house, and were able to do so in part because the rent from our tenants (who are good friends, as well) basically covers our mortgage. Not having to feel tied down to a particular city allowed me to take a risk on an exciting new job that I probably would have passed up if relocation had involved selling our house.
What's your down payment? Unless it is trivial (3 months rent or something like that), there's also the cost of making your down payment illiquid.
Sounds like it is still a good decision, but don't forget that cost as well.
If your mortgage payment is below the going rents (not too difficult to achieve if you factor in the tax write-off), then one way you can look at that is you give an $X down payment now for a free house in 30 years. If you look at it that way, slow growth doesn't look quite so bad -- the house only needs to be worth about $8X the down payment in constant dollars 30 years from now. Assuming 20% down, that's only appreciating 60% in 30 years, which is only assuming about 1.5% growth in home value per year.
Inflation should probably also factor into your analysis, for those who believe that inflation is likely in the long term.
Buying a home also offers a lot of stability on your long-term housing costs. Even if you buy and sell every few years anyway[1], the fact that you are both buying and selling at the same time leads to a fairly even end result. With renting, you are always purchasing on the spot market[2]. Avoiding risk and having control over when you move both have a value.
[1] Of course, buying and selling every few years is very costly, but it doesn't affect the stability argument.
[2] And it's not just luck when you happen to be moving around. If you are buying into an area because of a new employer, there's a good chance that the employer is hiring, and that a lot of people want that same apartment.
The way I would look at it is that I buy housing the way I buy groceries, clothes, and pretty much everything else: I buy it when I need it. I mean, sure, if I bought an orchard I could get apples for "Free" after I'd paid the mortgage, but that's just bad accounting.
The problem with buying a house is that it's a massive bet on your local labor market. Your job (your biggest asset, in terms of net present value), is also a bet on the same market. You're levering up massively in order to bet on one of the biggest un-controllable risks you face, and you're paying 7% transaction costs on the purchase and the sale in order to do so.
A cheaper way to make this bet is to borrow several times your annual income, and bet on your being laid off (i.e. you make money if you don't get fired, and you do make money if you do get fired). That would be a terrible decision.
Not usually true. Investment properties are not subject to mortgage interest tax deductions. http://en.wikipedia.org/wiki/Home_mortgage_interest_deductio...
http://www.ritholtz.com/blog/2011/04/case-shiller-100-year-c...
Buying things for the future (whether housing or cattle futures) does offer price stability and insulation from market fluctuations. It doesn't automatically make it a good investment; but stability is good, and it's perfectly rational to assign some positive value to it.
I was just trying to put things in perspective. There are perfectly rational reasons to buy a house. When the rents are higher than what a mortgage payment would be, it's a pretty reasonable thing to do for a lot of people, based on some pretty reasonable projections.
You can still disagree, of course. You can say that 1.5% growth per year in home value is too much to ask. You can say that rents will fall, therefore making your mortgage payment higher than rent. Or you can say that a 7% return is not good enough for you. Or maybe my analysis was wrong, in which case you can point that out.
Stranger things have happened. Bankers have been wrong before. You could say that home sellers were right when banks who loaned money to buyers were wrong in 2006. I think inflation is likely to be higher than most people think, because there's no politically possible solution to the government's debt problems other than inflating our way out of it, despite its previous record of being a reliable debtor. If I'm right, that will mean that home buyers are indeed systematically better at accounting for inflation than bankers (or more like they will turn out to accidentally happen to be right).
At any rate, if the cost of renting is close to the cost of buying, as it is in my town (it's about the same here except that you don't have to fix the roof, etc, if you're renting), then even if I'm wrong, I won't lose much money as a new homebuyer in the next year or so.
>The problem with buying a house is that it's a massive bet on your local labor market.
That depends on your job. If you're have some specialized job or you're in a small town, that's something to think about, but lots of people have jobs for which they would never have to move. Even if that is an issue, it also depends on how comfortable you are with being a landlord, and how many people you know who would make likely good tenants.
My analysis still holds: if your mortgage is less than rent, then you can do calculations based on the price from the down payment rather than total appreciation on the home.
How the mortgage payment ends up lower is irrelevant. All I meant by the mortgage interest thing is that you have to remember to adjust downward a little to account for that.
People with children in any state of the United States that does not yet have public school open enrollment might consider asking their legislators to enact public school open enrollment, which works well in Minnesota, Iowa, and perhaps other states. Public school open enrollment, which has been going on in Minnesota for more than twenty years, gradually encourages public school districts (which are usually local oligopolies who don't have to listen to clients very much) to compete on the basis of quality and flexibility of their programs to gain student enrollment. Public school open enrollment also decouples decisions about where to live from decisions about where to enroll children in school, which is good public policy on several grounds.
http://education.state.mn.us/MDE/Academic_Excellence/School_...
After edit: In relation to comments in other subthreads here, about the cost of paying a mortgage versus the cost of paying rent, the odd thing about the bubble economy in this town is that mortgage payments got to be MUCH higher, even at low interest rates, than prevailing rents for the same or very similar properties. It has been financially advantageous for a long while in this market to rent rather than buy, and perhaps still is for several years to come. The whole issue is fraught with public policy implications and sometimes very difficult economic assumptions.
http://minnesota.publicradio.org/display/web/2011/05/11/hous...
http://www.twincitiesrealestateblog.com/
http://www.usatoday.com/money/economy/housing/2010-08-11-hou...
http://www.boston.com/bostonglobe/ideas/articles/2009/03/22/...
http://www.clevelandfed.org/research/commentary/2011/2011-03...
http://www.clevelandfed.org/research/commentary/2011/2011-06...
Consistent rent increase is a very important indicator because it means couple things:
- More people are moving into an area, due to new jobs, more economic activities, etc.
- It's easier to rent than to buy so people moving into an area would rent first. Buying takes more commitment so it lags. Rent is a leading indicator of buying.
- As more and more people move in, housing supply can't keep up. Vacancy goes down. 5% is kind of the frictional vacancy barrier. At below 5%, rental market is white hot. Rent would creep up slowly first and then faster.
- The rent vs buy debate would tilt to the buy side.
- With more people in an area, lower vacancy, and ever increasing rent, more people will favor buying.
- House price goes up as a result.
In the last cycle in the SF Bay Area, rent had noticeable increase starting around 95 and 96. House price started going up around 98 after being flat since 89. Rent became white hot around 2000 and 2001. Then crashed at the dotcom bust. But house price kept going up abnormally because of Fed's low interest rate policy until the 2005/2006 bust.
The only problem is that I have been hearing the very same claims for almost 20 years by now.
...I have been hearing the very same claims for almost 20 years by now.
This is depressing advice, no matter how many empirical studies back it up. I don't think I'd want to live around people that were wealthier than I'd ever be, but I would certainly want to live around people that were more energetic, socially outgoing, ambitious, and involved in the community than me.
Whatever you value -- you should hang around people that are better at it than you are. If you are a hacker, work with people that are smarter than you. If you want to exercise more, spend time with people who exercise twice as much as you'd like to. Et cetera.
Then what should we do? :(
Article says that making things explicit is bad, but on many occasions I read that making them not explicit is also bad - because mind is a convoluted mess and dumping things from head to paper helps see everything more clearly and consider more details, freeing up mental resources for more ideas to come. That's both Creativity and GTD 101.
Am I missing something here?
But still, does that mean that explicit cost-benefit analysis is bad? Or, when I'm confused about an issue I need to decide on, if I do a mind-dump of things related to that issue, does that lead to poor decisions? I'm asking, because so far I find it extremely helpful to do a mind dump, when I feel confused.
I find this amazing. Commute (unless done on bus, etc) is lost life. Every day, twice a day. Commute is almost top of my list, although it influences choice of job more than choice of home because the former varies more often and is less important than later. > 15min 1way commute is bad. 30min or more is non-starter. I factor in commute time as "time at work" to compare if one job pays more than other.
I also agree with the advice about commuting. I made that mistake when I was 24 and bought my first home. The extra $15/month mortgage payment (this was in the 1970s) for a comparable place near my job seemed like too much money, but after a few years of inflation, transportation costs, and my time, I regretted my decision until I moved and started using it as a good income property, which I still have.
Also good advice in the article was the part of paying attention to relative pricing (i.e., don't spend $35K more because the difference between $735K and $750K psychologically seems small).
I have always favored buying less expensive properties to live in but also have a few income properties.
What's happening to the housing market in the US is incredible, but in case anyone is interested in a foreign view, read on.
In the US:
- Most types of mortgages in the US are tax deductible.
- Interest rates are fixed for the entire term of the mortgage.
- Houses cost 2-5x average family income.*
- Some states allow homeowners to walk away from mortgages.
http://www.ritholtz.com/blog/2009/02/us-existing-house-price...
And yet with the housing market in the US is still in shambles. In Canada, we don't have the luxury of these three things.
In Canada:
- Canadian mortgages are not tax deductible. http://en.wikipedia.org/wiki/Home_mortgage_interest_deductio...
- The average mortgage in Canada is a 5-year fixed rate mortgage. That means you lock in your interest rate (approx. 5%) for at most 5 years, then you need to re-mortgage. Interest rates can change drastically in 5 years.
- Vancouver currently has a house price to average annual income at 10x. That number is double the value of when the US peaked in 2005-6.
- Homeowners cannot walk away from their mortgages. I think it's called "personal guarantee" or something. IANAL, but bankruptcy doesn't necessarily clear out a person's mortgage debt.
So while the US housing market is terrible, you guys have some amazing perks for home owners. Just remember to never use more than 33% of your monthly income to carry your mortgage, and don't look to your house as a way to make money.
At the end of the day, a house is a consumable and not (necessarily) an investment.
* I'm not counting places like Detroit, where I've heard rumours of plots of land going for < $100.
As in most things, the Americans are just ahead of the curve. And as a Canadian who lived in Southern California from 2006 to end of 2010, I think our friends there who were finally able to afford to buy a house after the housing bubble burst would dispute your conclusion that the US housing market is "terrible".
There isn't consensus that there is a bubble in the housing market, but some economists have produced detailed and convincing analyses that this is in fact the case. The price growth has been fueled by low interest rates, immigration and low construction rates due to bureucracy.
There is a hidden difference. That extra $35,000 may mean the difference between getting financing and not getting it. (I have a friend with good credit who was almost rejected for an 800k house even though he put half down.) I don't feel that most people have an extra $35,000 lying around that isn't used as a buffer.
Now I understand there are some ownership qualities to so-called home ownership, not denying that. There are shades of gray between pure renting and pure owning. But what most people talk about is something clearly in the middle of that spectrum, not on one end. Thus, I think the better description is different variants on renting. Different lease permutations.
Flip comments aside: "ownership" of anything -- a ball, a company, a piece of property -- should be seen as a bundle of rights and responsibilities, and as a (overall) benign socially sanctioned fiction like streetlights. Then you can see that it is only in the trivial cases, like a ball that nobody cares about, that ownership is straightforward and implies "It's mine I can do anything with it I like".
So, duh, you pay taxes and have to conform to zoning codes. Get over it.
EDIT: Also, "government entities" aren't some weird uncontrollable force like the weather or an invading army -- you live in a democracy, so get involved.
If you don't want to support existing infrastructure, I suggest that you become very wealthy, buy an island, and live there by yourself.
The difference between buying and renting is enormously larger than the difference between buying and your theoretical-complete-ownership-of-land. Additionally, in your theoretical ownership world, you would have zero infrastructure to support you and, indeed, would never have had the economic engine to build your wealth in the first place.
Water, electricity, and gas infrastructure can be paid for by taxes on those services, and people who don't want them can not purchase water, electricity, or gas from the "grid". Roads can be paid for with gas taxes, and that way are paid for proportionally by those who use them.
And to add to the GP's post, government can choose to seize your land at any time using eminent domain laws are are more and more abused every day. So, whether or not you agree with Libertarianism, I do think he has a point that there are a lot of similarities between buying and renting that a lot of people maybe don't realize.
I think that the choice of paying property tax and living on an island is a false dichotomy. We could theoretically live in a society without paying property tax, where the government can't seize your land.
One of them is that this "men with guns" phrase is often deployed to plant some kind of "government over-reach" meme around the most trivial of adult transactions, like paying parking fines and property taxes.
It betrays a childish political naivete. The reason I say it's childish is that it's egocentric, as if the concerns of the speaker (to park where they want, to own large plots of land, that abut other people's land, without any consequence or restraint) were the only ones in existence.
That house is served by roads, protected by police and fire services, and must be in compliance with various perfectly reasonable regulations (like brush clearance). That costs money.
And last, you know where your phrase, "All power comes from the barrel of a gun", comes from, right? Good old chairman Mao, one of the top guys in the 20th century rogues gallery. In a democracy, with functioning courts, this saying is more hyperbole.
I think a more relevant notion is that the state is the entity that has a monopoly on violence (due to Max Weber, see http://en.wikipedia.org/wiki/Monopoly_on_violence).
That's a ridiculous simplification. You may as well say, "all power comes from tanks," or, "all power comes from nuclear arms."
If the county takes your house, the sheriff will come out to escort you off the property. Guns don't come into play unless you pose a threat to their lives. Even if guns do come into play, that's still not ultimately the force that moves you. Being outnumbered by a better organized group is what ultimately forces you out. The guns are just one small part of the puzzle.
The thing I fear though is the in-between period. Many folks will hold on thinking that the downturn is "temporary", so prices will stay elevated for a few extra years. As a consequence, you'll see doubling-up and tripling-up in housing that normally would have held only one family.
But this is just a linguistic conceit on the part of home buyers.
There are mansions (homes that you can't afford), nice homes (homes that you can afford, and are in good condition/areas), and there are slums (homes you can afford, and in bad conditions/areas).
No one wants to live in a slum. No one can afford a mansion. So a 'nice' home is the only realistic choice.
Seriously, housing is one of the best inflation hedges.
The location thing rings true, you tend to underestimate it. I've rented 4 places in the past that weren't in an optional location, but cheaper, and 1 (now) in a great location, but smaller. I like the great location much more.
The money thing is also true: you tend to underestimate large costs (20K, say), if they're part of a much larger cost.
And again, the third one (pool) is also true. Pools are really rarely used. Living in the city becomes much more enjoyable once you realize this.
Light and nature, again, spot-on. As a sidenote: I'm enjoying nature almost as much now (in NYC) as when living in the mountains of Colombia. Just to say that living in the city doesn't exclude access to nature (parks!).
And finally, listening to your gut, again, spot-on.
So actually (and again, I've rented AND bought), pretty good advice.
It's nice to have a modest house in an up-and-coming community with lots of light and easy access to the workplace. But then you discover that the up-and-coming community has a fire and police district that can't keep up with the growth. So either they try to get by with a shoestring municipal infrastructure, or the taxes skyrocket.
Then you discover the county has overbudgeted during the boom times and hasn't cut back on anything. Taxes are going up again to make up for the incompetent government.
Then the poster starts a family. Whoops, that home that was so close to your workplace is 10 miles from the school. Now you're driving the kids to daycare or school or paying for bus service. Or you discover that the nearby school sucks and is full of gangs but the schools in the next town over are light years better and safer. Private school time.
Then the roof goes. The power grid cuts out every time a squirrel farts on a wire. The 100-year flood plain is really a 10-year one these days.
It goes on and on. Trust me, home ownership has it's upside but a lot of it sucks as well.
This! I live in the middle of the city and have access awesome parks and gardens where my daughter can run around and play within 20 minutes walk of my apartment. I doubt I could find anything significantly better by moving out to the suburbs.
The original point I was trying to make is that purchasing a home isn't an equation with 5-6 variables as the original poster has tried to point out. It's an equation with 200 independent variables and you won't know the answer to 50% of those until after you move in.
All the rational thought and decisionmaking won't inform you to the fact that the neighbors like to party outdoors until 4am, or the factory across town has decided today to move to Mexico and decimate the taxbase of the community.
You can never get all the variables right. All you can do is give it your best shot and learn from experience.