Wall Street Unlocks Profits from Distress with Rental Revolution
bloomberg.com
bloomberg.com
This is an insane comment, for the reasons Matt Yglesias discusses in The Rent is Too Damn High and, to a lesser extent, here: http://www.slate.com/blogs/moneybox/2013/04/26/housing_isn_t... . Over the long term buying versus renting should ideally be revenue neutral, and whether or not you can "build wealth" via a house depends in large part on where the house is. Someone who bought a house 30 years in San Francisco or the west side of L.A. has made a lot of money. Someone who bought in the greater Detroit area hasn't.
The myth that buying a house is a key to unlocking wealth needs to be addressed and yet is too often propagated by journalists.
EDIT: See also this: http://www.slate.com/articles/business/moneybox/2011/05/the_... .
It most certainly is, for journalists. Take a look at the ads and follow the money. You're not going to sell ad space to home depot or the local real estate agents if your readers are renters.
Also revenue neutral is not as strong of a claim as inflation neutral. A stick built box of air is the new "gold". A non-performing asset which varies in price somewhat scarily, but more or less on a long term tracks median income, which increases at a lower rate than inflation but not too much lower (else you get a revolution)
In addition much of our media and the people within it have a vested interest in property price rises, usually because they are up to their necks in buy to let property.
Exhibit number 1 from here in the UK. http://1.bp.blogspot.com/-Un_cxT0Q4M0/Tw7ZZCg1feI/AAAAAAAABg...
And I'm not claiming just big box DIY stores, but listing real estate agent ads, bank and mortgage broker ads, home repair, upgrade, and maint ads (plumbers, roofers, etc) and last but not least real estate developer / condo advertisers. Don't bite the hand that feeds you, especially when you're really hungry.
There's also a lot more of what you might call undeveloped land in the U.S., where large pieces of land are privately owned and carry little in the way of building restrictions (and maybe in addition the land is not very productive for forestry or agriculture).
You buy a smallish house in a suburb and pay $1000/month for you mortgage. $900 of that goes directly to equity.
At the end of the year, if you home retains its value, you have over $10,000 in equity.
If you pay the same amount for rent, you have nothing to show for it. And oftentimes rent for an equivalent house is actually more than the mortgage + tax payments.
So, which is better $10,000 or $0?
The volatility of the last few years has complicated this a bit (people going underwater, for example), and I don't think people should see a home as a vehicle for getting rich, but it is generally a nice value store.
Plus, there are HUGE advantages for people invested in the area to own their property. It is more stable for them (they can't be kicked out), they are more likely to invest in the value of their area (volunteerism, making sure local politicians take care of the parks, reporting crime, that kind of thing).
Edit: Let me point out that yes, these numbers are made up and don't accurately reflect reality. I did not use a mortgage calculator or anything (I thought that would be obvious) but the underlying idea that I was trying to convey holds....if you are spending x dollars and are able to store any portion of that in something that holds some value it is better than spending x dollars and not storing any of that value. So, even if only $10 of every $1000 spent on the mortgage goes into equity, it is better than $0 if you rent.
Equity contributions only ramp towards the very end of the term. Up front, you are paying mostly interest.
Due to how amortization works, it's very unrealistic to assume that with a $1k/mo mortgage payment, that $900 of that is going to equity. In fact, in most cases (standard down payment, 15 or 30 year mortgage, etc.), it'd be closer to the opposite of what you outline, especially at the beginning of the loan term. You can pull up a calculator to see for yourself but typically in the first few years of a new mortgage you'll be paying closer to $900 of that $1k towards INTEREST with the remaining going to principle / money that you may see later assuming home value is indeed retained.
That said, I hate paying rent -- but I've also been "burned" a bit on home purchases a couple of times, too! ;-)
EDIT - As someone above mentioned, you also have to keep in mind things such as PMI, property taxes & special levies, upkeep, etc...
Ultimately, what we really need is to go back to a system where people can actually afford the homes they live in. The vast majority of Americans, whether they "own" or "rent," are still renters with no real chance of ever actually owning their home outright. If that perception changed, prices would come down, and we'd eventually get back to a system where you could buy a home for 2X your annual income.
The problem with a return to a sane system is that it would bury existing homeowners, and we aren't willing to accept the pain in the short run. We need to artificially inflate housing prices in order to allow people to sell their homes, keep the economy functioning etc. So, in short, we're stuck.
http://www.doctorhousingbubble.com/wp-content/uploads/2013/0...
Owning a home can be a good thing, but it isn't just easy money and wealth.
Part of the reason "common sense" doesn't apply to this situation is that a huge number of factors (and costs, and risks) do apply. Maintenance and taxes are going to cost far more than $100 / month. For example:
* these numbers don't include a down payment on the mortgage
* they don't include transaction costs in either buying or selling
* they don't take into account interest on the mortgage versus how much the same money would appreciate if invested in an index fund instead of a house—in other words, the time-value of money.
* they don't take into account (and can't) how valuable moving might be; in finances, options are usually valuable because of their flexibility.
* they don't include homeowners insurance.
In short, "common sense" is anything but. That's why it's dangerous to do simple, back-of-the-envelope calculations about a major decision in the lives of most people.
But essentially, even if you only bank $10 in equity, $10 is better than $0 you'd bank if you paid rent.
Heck, then I'll do the same. Let's just pull some new numbers out of the air such that the rent is $20 cheaper than the mortgage payment. Now as a renter you can bank $20 in savings, which is better than the $10 you'd bank in equity if you had a mortgage. Problem solved!
$500,000 30yrs at 4.25%
20% down $100,000
$1967.76 monthly payment
$22,644 closing costs
By year four you are in the black compared to renting by $6132 You'd need an investment on your $100,000 that returns 1.49% compounded annually to make up the difference if you rented and invested the $100K that would have been spent on the down payment.
By year five you are in the black by 14,122 You'd need 2.645%
By year six you are in the black by 22459 You'd need 3.382%
7 31157 3.881%
8 40233 4.234%
9 49701 4.5%
10 4.683%
30 5.222%
Here is the amortization chart: http://www.myamortizationchart.com/30-year/400000-dollars/4_....
Here is the closing costs calculator I used: http://michaelbluejay.com/house/closingcosts.html
In short, you have a pretty good shot at breaking even between renting and buying if you invest the down payment. If you have less than a 20% down payment (3% I think is what you need for a FHA loan) then you reach covering the closing costs faster with accumulated principal payments but your monthly payment can be significantly more (up to 20% more a month). IOW a huge amount depends on what you can rent the same house for. If rent == mortgage + tax these calculations hold. If rent is less than it is almost always going to be better to rent. If rent is more you are looking at a better situation buying if you are staying more than a few years. Also, interest rates would play a huge part.
For example...interest payments will not eat 100% like rent so the fact that interest payments could be higher is nearly irreverent.
You can pay $400/year for maintenance protection for your home so the maintenance costs are nearly negligible.
This is the most significant factor you mentioned:
The middlemen payments amount to less than 5% of the purchase price (for the purchaser). This can be a problem if someone needs to buy and sell relatively frequently but as long as it doesn't add up to the difference between rent and the amount of equity stored in the time that the person owns the home it is still better to buy. But, you are correct, this is a significant risk.
Keep in mind, we are not talking about owning a home as an investment. We are talking about owning a home compared to renting. As long as you are not taking a a full loss and then some it is still superior to renting which is a guaranteed 100% loss.
Yes, if the amount you save by buying outweighs what you spend on buying, then you're better off buying. That is actually "common sense".
But the problem I have with your supposed "common sense" scenario is that it completely ignores this by claiming that having a small amount of equity after a year is a win. Buying a house loses money up front. The only reason it's worthwhile is if the long-term tradeoff is worth it. That long-term gain almost never happens after a single year. It's typically 5-10 years before you break even.
So no, $10 in equity is not better than the $0 you'd bank if you rented, because you're ignoring the tens of thousands of dollars you paid out up front.
In other words, the opportunity cost of capital is not always accounted for in these comparisons...
Opportunities are what you make of them.
For most Americans, who move around fairly often, they will never come close to paying off a mortgage and the only equity they will ever own will be what they bought with their down payment plus whatever they get on the margin if the value of the house goes up.
If you, say, live in a house for five years and then move, then you basically rented the house from the bank for five years. Except that unlike a renter you also assumed the (upside and downside) risk of home value change, and assumed the cost of taxes, maintenance, etc. Plus you tied up a large sum of money in a down payment.
This may be worth it if you want to bet that home prices will go up in the next five years. It also may be worth it because mortgage interest, unlike regular rent, is deductible from your taxes, which is perhaps the most obscenely regressive thing in the tax code.
Your math example is silly on two counts. (1) you simply assume the rent and mortgage cost exactly the same, when they generally don't. (2) you ignore the downpayment. A renter doesn't have to make a huge downpayment, so if s/he has the money to make one, that is valuable flexibility - one can easily use that money in an emergency and can profit by investing that money in the meantime.
There are a lot of factors that can change the calculus. Buying is not always for everyone. People who move a lot where fees can eat up any benefits. Or people who do not have down payments or other cash flow problems (which can be a pretty effective market moat).
Rent, though, is often pretty comparable to a mortgage + taxes. In my area rent is substantially more for the same house.
So, liquidity is an important factor, no doubt about it. But I think one would be hard pressed to make a consistent investment profit that would make up for your 100% loss in rent compared to purchasing all other things being equal.
why wouldn't the next mortgage be a 20 year term? that's a like for like replacement at that point.
Mortgage: 100,000$
Term: 25 yrs
Rate: 1%
Principal payment for the 12th month: 59.38$
Interest payment for the 12th month: 993.84$
Cumulative interest after 12 months: 11,998.64$
Cumulative principal after 12 months: 675.02$
All this with an incredible 1% rate.
Storing any amount of money for the amount spent is better than banking none of that money.
Honestly I downvoted your earlier comment specifically because of your edit saying that it doesn't matter if equity is 900/1000 or 10/1000. It matters a hell of a lot. Only a fool* would avoid putting 900/1000 into equity, with an effective 'rent' price of 100 if they move out after a few years. But there are real decisions to be made if just about none goes to equity.
*assuming they expect to live in one place for a while
Of course when you are down to a 1% storage of wealth other investments become much more attractive. You could rent the equivalent house (assuming price is the same) and be confident that you could make up the difference by investing what you would spend in transaction fees etc.
It doesn't take much improvement in that storage rate, though, for that confidence to evaporate.
It's not just the cash flow which matters, you must consider many other factors. Have you heard of "depreciation", you know the expenses required in order for your house to keep its value? It's a whole lot more than the "10$" gained in the first years when using a mortgage. You keep focusing only on the cash flow of one part (mortgage vs rent) of the whole deal and ignore everything else. That's nonsense.
And because you "simply" forgot to include maintenance and property taxes, you end up being just plain wrong. In reality, a house is a money pit in the first years of the mortgage. Whereas in your simplified example it looks to be a good deal because it's assumed one is gaining $10K in equity every year.
$500,000 30yrs at 4.25%
20% down $100,000
$1967.76 monthly payment
$22,644 closing costs
By year four you are in the black compared to renting by $6132 You'd need an investment on your $100,000 that returns 1.49% compounded annually to make up the difference if you rented and invested the $100K that would have been spent on the down payment.
By year five you are in the black by 14,122 You'd need 2.645%
By year six you are in the black by 22459 You'd need 3.382%
7 31157 3.881%
8 40233 4.234%
9 49701 4.5%
10 4.683%
30 5.222%
Here is the amortization chart: http://www.myamortizationchart.com/30-year/400000-dollars/4_...
Here is the closing costs calculator I used: http://michaelbluejay.com/house/closingcosts.html
In short, you have a pretty good shot at breaking even between renting and buying if you invest the down payment. If you have less than a 20% down payment (3% I think is what you need for a FHA loan) then you reach covering the closing costs faster with accumulated principal payments but your monthly payment can be significantly more (up to 20% more a month).
IOW a huge amount depends on what you can rent the same house for. If rent == mortgage + tax these calculations hold. If rent is less than it is almost always going to be better to rent. If rent is more you are looking at a better situation buying if you are staying more than a few years. Also, interest rates would play a huge part.
Where I live renters pay a $300-500/mo premium over what they'd pay if they had a mortgage.
I sure would like an extra $6000 a year to go to building my wealth vs building someone else's, wouldn't you?
Edit: That money is almost pure profit here as well, because the homeowners here don't put any money into upkeep and most don't even pay their PoA/HoA fees as most of those are bankrupt here and having a hard time collecting from anyone.
But they're never even, and that's the point.
I don't want to get on my LVT preacher's box, but man would I be pleased to see that happen.
>I sure would like an extra $6000 a year to go to building my wealth vs building someone else's
That's the crux of the argument here. Money that would otherwise be spread around (the difference between owning and renting) instead lines the pockets of the shareholders of private equity firms. It's almost like a forced tax, because if you have to live in an area (e.g. can't move because of family, employment, access to schools etc), but are outbidded from the house you'd otherwise be able to afford - that means you are forced to rent.
In my situation I don't mind it right now. It's a lot cheaper than living in New York and I work remotely. There's absolutely no decent work here, so I don't want to be trapped owning a home down here.
Unfortunately, I'm starting to realize that with my increased travel costs, living in New York would still work out better for me financially and (more importantly) socially.
Today. Tomorrow it may change. (Where is this, by the way?)
Rents follow the revenue more closely. A mortgage is fixed.
Rents also give you much more flexibility. If it's too expensive you can move somewhere else. Just ask those who tried to sell their houses to pay the mortgage but who were still short.
The best part is that this area has been growing significantly for ~20 years now and is only going to get bigger in the next 10. Values are steadily climbing. Homeowners here are making an absolute killing doing almost nothing to maintain their property. Folks who've lived here a while are getting rich.
My understanding is that long term fixed rate mortgages are a USA thing. I don't think such a thing as 30 year fixed rate mortgage exists in Europe, for instance.
And in some places there are 'fixed' mortgages that have some form of inflation adjustment
If you rent money from the bank, there are all manner of crazy terms ranging from fixed to adjustable to a variety of bankruptcy inducing option / balloon payment schemes. In Europe they only offer short adjustable terms. You never signed a contract with the local taxing authority you're renting the land from; some places thats stable, some not. I pay about $300/month rent to the city to rent the land my house is on. If you don't believe you're a renter instead of an owner, go ahead and try not paying your prop tax and see who really owns the land.
If you rent a box from a landlord, there are a variety of lease terms which depend on local and state law in addition to whatever deal you make. I lived in a bachelor pad for six years and had my rent locked in for two. Its a big planet, I suspect there are strictly month to month rentals out there, and there are probably also five year lease terms, if you want extremes.
It is true that all things considered renting is more flexible but each division has more internal diversity than the average difference in diversity of both classes.
Long term renters do put work/money into their apartments. My mom has put probably twice that into the NY apartment she's been renting since 1970. She did work that the landlord was unwilling to do or do quickly (we were repeatedly flooded out by our hoarder upstairs neighbor in the '90s and the landlord dragged their feet on repairs because they wanted a rent controlled tenant out).
When you say you put $40k in work into your house and got $3k more than you paid for it, are you saying that you got $43k over your purchase price? If not I think we need to take another look at your accounting process here: a) the $40k is optional and b) if I'm right about your math, a bad investment.
Not trying to be rude. If it comes off that way, sorry.
a) Yes the $40K was optional, but we probably would have had to sell for $20k less had we not done the work. Bringing our "ownership tax" to ~$275 a month. Pretty close to the lower end rent premium you mentioned above.
b) It was absolutely a bad investment in straight financial terms. We did get the pleasure of a nicer house, for what it's worth.
Also not trying to be rude :)
Not as an investment, but as a value store?
So for our second house we looked for a place with "no potential." The early 90's kitchen had already been updated, the basement is finished, etc.
Edit: Clarification.
So, even without a standard risk model the market usually prices risk within a bound.
I agree that the market tends to price some sort of risk. However, the discussion was "ownership vs rent", with the consensus beIng the cost should be equivalent under some measure; however, some expect it to be cashflow neutral, some inflation neutral, and some risk neutral. Of these, the first two can be quantified but the last cannot - and it is therefore not useful in the discussion of whether the prices make sense.
After more than 100 years of discussion, there is still no consensus among economists over whether one should maximize expected value or expected logarithmic value.
People often mention use "on a risk adjusted basis" without qualifying the adjustment - and that's a useless thing to do.
Even buying a primary residence is a reasonable path toward wealth if one plans well and is willing to sell and move somewhere cheaper when the time comes.
If wealth from land ownership is all about location and timing, then you have insane advantages like being lucky enough to be born before the next schmuck who wants some land.
Come to think of it, if you really wanted to invest in your future generations' future, one of the best investments you can possibly make (albeit risky) is to stake claims on the Moon/Mars/Asteroids/etc. I totally need to rethink my position on Plantary Resources and Deep Space Industries.
Intrinsic liability, you mean. My little plot of land comes with a $300/month prop tax liability aka "rent" in addition to the costs of ownership. And of course land comes with unlimited legal liability unless you pay $50/month or so for liability insurance.
BTC of course costs nothing to store, although most people who will store it for you would like to skim, and/or there is some fundamental lower limit on the cost of storing/maintaining a wallet.
As for gold, you'd be shocked what can be fit into a mere $25 credit union safe deposit box and for the $350/month that my land costs, I could get a safe deposit box big enough to park a motorcycle or scooter in it.
In some ways gold is free, in the same way that unless you're a lunatic you have some kind of off site digital backup scheme with flash drives getting rotated monthly or so into a safe deposit box so the empty space could hold some coin. Of course in the same way BTC is free because you've got a backup scheme anyway and a wallet is pretty small. Either are much cheaper than "owning" land.
"In October, Bloomberg reported that a hedge fund,
Magnetar Capital LLC, had quietly bought 1 out of every 11
homes in the Ohio town of Huber Heights and then pushed
for property-tax cuts that would have blown a hole in the
school district’s budget."
Furthermore, this is setting things up for changes in landlord-tenant laws. The level of lobbying power and expertise in tenancy laws they are going to accumulate is going to make them a formidable foe for tenants rights groups to fight against.
I fully expect this to get pretty ugly long term.
This is part of the reason why this trend is so terrible. The Hedge Funds do not care about long term investments or the long term health of the neighborhood. You squeeze as much money out of your investment as you can and then get out of it before the day of reckoning comes. It's the stock market mindset applied to every single assert class.
This is an excellent phrase to describe this phenomenon (and probably many others).
If two parties want to sell each other stocks bonds (asset classes likely purchased by deep pocketed, sophisticated investors), and the asset blows up, fine. Both parties can afford to take the hit. But where those assets are basic essentials, it's just downright slimy.
Oil: http://www.nakedcapitalism.com/2012/05/les-leopold-how-wall-...
Food: http://www.theguardian.com/commentisfree/2013/may/23/goldman...
http://www.propublica.org/article/the-magnetar-trade-how-one...
http://www.thisamericanlife.org/radio-archives/episode/405/i...
What I have found, There is a near conspiracy level arraignment between banks to completely undervalue the properties, give higher interest rates, require a greater stake, and lower the borrowers acceptable debt-to-income ratio. I had three appraisals come in, the bank appraisals were all manipulated and internally inconsistent, and LOW. The independent appraisal I had done came in rationally.
When I was house hunting (both in 2009 and 2011), my wife and I would break into the empty foreclosed homes to tour them and inspect them for damage. No one, realtors or bankers, would ever respond to calls regarding the properties, no offers were ever responded to by the banks. All of these properties in our neighborhood were eventually sold, and to big investor groups. They are now predominantly rentals. Our experiences at the time showed what we perceived to be a fixed market where the realtors were holding out to sell to their friends. Now we realize that they were holding out for the institutional buyers.
As a side note, realtors are the absolute scum of the earth. Worse than lawyers.
Apologies in advance to any lawyers.
Any shitty experiences you've had with real estate agents are probably better explained by Hanlon's Razor. There are a few exceptional real estate agents, but my experience has been that real estate is a profession for those incompetent at everything else. When they say prices are going to keep going up and that it's a great investment, they usually actually believe that fully. They have bought whole hog into the idea that real estate is the best investment and that prices keep going up. You can't even work as an agent if you don't really believe that since that is the only condition in the market that is really in your interest as a broker since it's the condition where liquidity is highest, and liquidity is the best thing for brokers. If you don't harbor that believe you either stay out of the market/profession entirely or you enter the speculative side of the market, buying low and selling high.
Those who can do, those who can't do anything, broker real estate.
FWIW, this largely applies to residential real estate. In commercial real estate, the brokers are a lot more like the banksters promoting a kleptocracy.
Related, I am interested in the following questions and am looking to do some research in the new year to investigate:
1. How much is paid in home loan interest to banks annually. 2. How much of this bank income is paid in interest to (a) savers, (b) other issuers of debt 3. How much of this bank income is paid in dividends to bank owners. 4. How much of this bank income is paid in salaries to bank staff. 5. How long the average home owner spends working for the above three categories in their quest for home ownership (I look at this as a form of indenture).
Following this article, I will also be looking at the question of how much in rental income is paid to financial institutions.
I am also interested in the relationship between bank lending and house price increases, ie as banks lend more, do they understand how this affects future business, ie an increase in lending of 10%, leads to house price rises of x%, leading to an increase in bank income of y%.
I guess there must be such models out there?
Any sources of data / reading would be much appreciated!
Dude who pushes / approves loans in the modern system does not equal dude who holds the note.
You might find thehousingbubbleblog.com or zerohedge to be interesting reading although it takes a bit of study to understand whats going on.
That's a nice racket.
I'm not convinced this is a racket. Whereas selling bad mortgage-backed bonds was definitely a racket.
One thing I don't fully understand, why don't the lenders themselves auction of the properties rather than keeping and profiting off the foreclosed properties themselves?
(1b) American taxpayers bailout insolvent securities firms whose whole business is supposedly predicated on competent risk assessment as a core skill yet totally ignored best practices to threaten the entire economy.
(1c) Pays themselves handsome commissions.
(3 addendum) buys the houses at a low cost made so by the bubble they created _with the bailout money of the taxpayers!!!!!_
(4b) destroys communities, defunds schools, further atomizes and disorganizes the modern American society
P.S. If you live in a detached "mother in law unit" in San Anselmo, CA.; you have rent control. Look into it. If your Landlord has been overcharging you take them to court and get all your over payments back.
The FED is as federal as FEDEX it's privately owned by the big banks. You can read more on how it was created over here: http://www.bigeye.com/griffin.htm
Yes, some companies have been buying single family houses by the truckload and turning them into rentals, but whether the model can be successful on such a wide scale remains to be seen. There are a number of major challenges, and the treatment of the publicly-traded companies in this space makes it clear that investors are well aware of them.
One of the companies mentioned in the article, American Homes 4 Rent, is publicly-traded[1] and raised far less in its IPO than it had intended in its original prospectus[2]. Similar companies, Silver Bay Realty Trust and American Residential Properties, are also publicly-traded[3][4] and currently trade well below their IPO prices.
Another company mentioned in the article, Colony Capital LLC, operates its rental venture through Colony American Homes, which pulled its IPO earlier this year[5].
Turning single family homes into rentals on such a large scale may prove to be a wildly successful business, and some of the issues raised by this article, such as the impact on the housing market, are worth discussing, but it's a shame that the article sports a baitlink title and gives the impression that there's no risk to the investors playing in this space.
[1] http://www.google.com/finance?q=amh
[2] http://www.bloomberg.com/news/2013-07-31/american-homes-4-re...
[3] http://www.google.com/finance?q=sby
[4] http://www.google.com/finance?q=arpi
[5] http://www.reuters.com/article/2013/06/05/us-colonyamericanh...
Under the Volcker rule, banks don't have an investment arm. That's why the article is about Blackstone and Colony, rather than Bank of America or Wells Fargo.
Postal services, education, national parks, government agencies turned "public-private." Water, utilities, roads, policing, emergency services! Rights and freedoms! The sky's the limit my friends!
On one hand, I viscerally hate that this is happening. It's shitty that the financiers (through wacky adjustable-rate mortgages, pump-and-dump games against the housing market, etc.) have taken communities and houses away from people. The "American dream" game is pretty rigged. On the other, I'm not surprised.
Wasn't Blackstone the pinnacle of prestige in private equity, though? I can't imagine them retaining that after going all in on the new suburban slumlord game.
How does one reconcile this with the idea that rental is disparaged as a practice of the lower income classes?