The point of this gloom and doom article is to make Eleau feel good about the $2000 a month he is flushing every month on rent.

So what would you recommend someone who already owns their own home and is considering becoming a landlord as a way of investing their extra income? Should they just sit out the current market in Bellevue (where I live) because prices are too high at present to make rentals profitable? Or are there ways to make Bellevue rentals pencil out even now?

Do you believe it is possible to find homes for sale in the Bellevue area today that would be profitable to rent out, even if there was no appreciation for 5 years or so? I definitely understand how rentals are working very well for landlords that bought years ago, but I am just trying to understand if today’s prices are attractive for new would-be landlords?

-gentrification: many neighborhoods have been upgraded from ‘working class’ homes to ‘trendy neighborhoods’… so comparing prices today vs. 10 years ago (in Ballard or alike) is not a 1:1

That works both ways. Some neighborhoods were once nice neighborhoods, and now are referred to as ‘da hood.

-demographics: retired boomers’ hold the wealth in our country… that does not mean that they have $200K incomes… (although many used to). Based on this, you will likely see many ‘cash’ purchases of condo’s ect as they downsize… the ratio’s of income to house price are not as relevant… we should be looking at income/mortgage valuations going forward to see if homes are ‘affordable’.
Boomers have less wealth thatn you think , and a sizeable chunk is in their home equity and the same 600 stocks that almost all Boomers own. One good punch to the stock market, and you will have a wealth destruction phenomenon that falls disproportionately on those Boomers. I am of the opinion that most boomers will only leave the office wearing a toe tag. They will not be able to afford to retire.

-inflation: if you have a 30yr fixed mortgage and we get into double digit inflation, that same mortgage will be easier to carry going forward. (yes, the downside to this is that the proceeds from the sale of your home will also be worth less in future $). Eleua is predicting DEflation… quite a different outcome.

I don’t want to hash out my DE-flationary arguments here, but if the future holds price inflation, rather than monatary inflation, then the outlook is for somewhat stagnant incomes with escalating costs of commodities and the necessities of life. That money will have to come from somewhere, which will likely be the large speculative premium that is in homes.

-pent up demand: I agree that there is some % of first time home buyers that bought before they were ready (due to the financing availability)… over the past year, there are many new first time home buyers that are itching to get into the game… if/when loans become available (loans right now are BEYOND historical requirements and are tougher to get than they ought to be…. lucky for those first timers who would have been sucked in to buying a house if they could have gotten the loan)… we should see the months of supply quickly reduce as the rate of sales goes up. The banks / govn’t WILL find a way to make reasonable loans in the near term. If they can’t, we may get 1/2 way to Eleua’s predictions.

When this is over, we will be rebuilding from a systemic banking failure, so easy loans are going to be things kids read about in history books, not reading about in their mortgage documents. Since the REIC has sold homes as “investments,” people are not going to be looking to jump in at the first opportunity. The knife-catchers that the sleazy RE agents are shoehorning into homes (because this is a generational bottom on home prices, right?) will have stories to tell, and they won’t be pretty.

-future expectations: the buyers in the market have LOW expectations for the near future 1-5 years… this is driving home prices lower even if a sell price is at a ‘fair value’ based on today’s comparables. If future expections shift to something even a little more positive than ‘a sure loss of 10-20%’, you will see buyers come back quickly… even ‘flat’ would attract buyers…

Doubtful. Once people realize that homes do go down in value, and if they do not have easy access to credit, they will take a very hard, and conservative look at housing. As PITI approaches parity with rent, then you may have people look more favorably at buying, but not until then.

-there are many people on the bubble so to speak as far as it making sense to sell now and come back when the market has bottomed… but for many, if you combine their expectation of 1-2 years of downturn, the transaction costs alone mean that they will be at about breakeven for selling and then renting….so likely they won’t sell. If they were right, and it gets better, they are ahead… otherwise they become the 2005/2006 buyers from a cushion perspective.

What happens if they are looking at 1993 prices and held all the way down? What if we get a 20-30 year bear market in real estate?

If the govt/banks do boy will things be worse ten years from now. Eventually, you have to pay the piper or your kids will — anyone for a couple more trillion on the national debt.

A few factors that I think are relevant, yet not as certain as a purely numerical cash flow analysis:
-gentrification: many neighborhoods have been upgraded from ‘working class’ homes to ‘trendy neighborhoods’… so comparing prices today vs. 10 years ago (in Ballard or alike) is not a 1:1
-demographics: retired boomers’ hold the wealth in our country… that does not mean that they have $200K incomes… (although many used to). Based on this, you will likely see many ‘cash’ purchases of condo’s ect as they downsize… the ratio’s of income to house price are not as relevant… we should be looking at income/mortgage valuations going forward to see if homes are ‘affordable’.
-inflation: if you have a 30yr fixed mortgage and we get into double digit inflation, that same mortgage will be easier to carry going forward. (yes, the downside to this is that the proceeds from the sale of your home will also be worth less in future $). Eleua is predicting DEflation… quite a different outcome.
-pent up demand: I agree that there is some % of first time home buyers that bought before they were ready (due to the financing availability)… over the past year, there are many new first time home buyers that are itching to get into the game… if/when loans become available (loans right now are BEYOND historical requirements and are tougher to get than they ought to be…. lucky for those first timers who would have been sucked in to buying a house if they could have gotten the loan)… we should see the months of supply quickly reduce as the rate of sales goes up. The banks / govn’t WILL find a way to make reasonable loans in the near term. If they can’t, we may get 1/2 way to Eleua’s predictions.
-future expectations: the buyers in the market have LOW expectations for the near future 1-5 years… this is driving home prices lower even if a sell price is at a ‘fair value’ based on today’s comparables. If future expections shift to something even a little more positive than ‘a sure loss of 10-20%’, you will see buyers come back quickly… even ‘flat’ would attract buyers…
-there are many people on the bubble so to speak as far as it making sense to sell now and come back when the market has bottomed… but for many, if you combine their expectation of 1-2 years of downturn, the transaction costs alone mean that they will be at about breakeven for selling and then renting….so likely they won’t sell. If they were right, and it gets better, they are ahead… otherwise they become the 2005/2006 buyers from a cushion perspective.

I put a 25% tax advantage for the homeowner in the comparison. In reality, unless the home owner has a large income, the standard deduction captures most of the itemized deduction.

- Mikal’s example is irrelevant. We can’t buy houses 10 years ago, only now or in the future. It’d be nice if we could all buy houses at 1998 prices, eh?
- Eleua’s Bainbridge example may be a bit off, but it’s not as uncommon as a few people seem to think. $2100 rent puts you in a $500-600k (early 2008 price) SFH or condo. It takes a lot of years (7-10) of steady rent hikes plus appreciation before buying pays off (becomes cash flow positive if it’s a rental). If declining/stagnant house prices are a reasonable assumption for another 1-2 years, 7-10 becomes 10-15. If owning the property for at least that long is not a reasonable expectation (and it probably isn’t for a lot of people), you never come out ahead.
- Renting absolutely has an ROI, and right now it’s positive. 10 years ago, not as much. Whether you want to call it opportunity cost or simply compare it to investing the cost difference between buying and renting, either way renting is very favorable (economics) right now.
- I looked at investing in two cheap places (one in WI, the other in IN) where nice homes start at < $100k (recently built 3&2 on 0.25 acre lot) and renting is better there, too. Or, more to the point, it takes a lot of years of eating huge losses before buying rentals in 2008 starts making money. Seattle isn’t special, the numbers are just bigger.

Yes, it is. Even the lumpenhomeowners agree with the premise, but they reflexively disagree for unknown reasons.

Anyone who buys anything now is out of their mind.

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Wasn’t the point of this post?

You guys put all this negative stuff and have me and Harvey counter it and you can’t handle it.

Delusional. Your objections were thoroughly dismissed.

It certainly can be a good investment. It isn’t right now, nor has it been the last 3-4 years.

Your arguments are really quite silly when you drone on and on about your rental properties. Here let me sum them up for you in an analogy:

I bought MSFT in 1994. Therefore, there was never a tech stock bubble.

I think you have had too much. Let’s continue this when you have less ethanol sloshing aroung your head.

People that were holding JNPR stock in 2002 were feeling pretty smug about the stock price, compared to what it was 18 months earlier. 18 months after that, they were not feeling so smug (98% loss).

I’m not comparing the valuations of homes 10 years ago to what they rent for today. I am asking if TODAY’s prices are justified by TODAY’s rents.

YOU BOUGHT 10 YEARS AGO. When there wasn’t a bubble! Your rentals should not even enter into conversations about real estate valuations and purchases TODAY. What Eleua says is not a strange scenario, any who has rented in the last couple of years can tell you that. I believe the entire point of this blog and everything discussed here is that around 2003/2004 things accelerated into a BUBBLE. If you bought before then, great! You do not factor into the discussion or comparison.

If it is typical for a $650K house on Bainbridge to rent for $2100, then that is the market price. This is not an isolated example, nor is it the worst. I chose it because it was very typical of what the rental market looks like.

That knocking on your door is reality. You are late for your appointment.

Just to be clear.

My sceario is real world. There is a house, owned by a friend, that has these numbers. A $650K Bainbridge house rents for $2100ish. If the numbers say for him to sell the house, as it does not justify the rent (MY ENTIRE POINT OF THIS BLOG POSTING), and he chooses to keep it, he is selling it to himself.

Make up your mind. Are you going to agree with my basic premise (speculative premium is very large at this time), or not (homes are fundamentally sound on valuations)?

I only read the first paragraph and I stopped. I would never buy a 650k house that I could only rent for $2,100. This is just more pretend scenarios. Yes, it is stupid to buy a house in your unrealistic worst case scenario. Your Enron rental earning schemes are just that, heady theoreticals that are truly baseless and laughable. At the end of 30 years you cannot cash your imaginary check.

You can tell people all day long about how you made 175k, but in the end you are just pretending. Your reality is that you are paying 2/3 of landlords mortgage.

Let’s pretend that you rent it for 30 years. In the end, you will have footed the bill for 2/3 or your landlords mortgage and he will own the property outright. This is assuming that your rent will never go up. What will you have?

OK, let’s pretend.

The scenario is as follows:

One guy rents a house for $2100/mo and another decides to buy a house and rent it out for $2100. The purchase price is $650k, with a 30Y fixed mortgage at 6.5%. Taxes are 1% (low) and maintenance is $500/mo over the life of the house. At these prices, this is not a new house, but an early 1990 era house, and he is going to hold it for 30 more years. $500/mo is a gift. Insurance is $75/mo and we will give the owner a 25% tax advantage over the lowly renter. The house is vacant for 10% of the time and a 10% management fee is in place.

The renter invests the excess money he saves over PITI at 5% and will draw it at the end of the 30 years. He pays tax annually on his gains.

At the 30 year mark, the two gentlemen agree to meet for lunch. The renter goes to the bank and draws his CD and pullsout $1,493,000 after taxes have been paid. His rent over the past 30 years totalled $756K. From his perspective, after taxes, he was paid $737K, tax free to rent.

The landlord sold his house on the same day he paid off the note for the original price he paid for it. He goes to the closing and collects his $650K, and pays Cookie and Candi, and all the associated fee and walks with a check for $605K. Over the same 30 years, he paid $1,586,000 in principal, interest, taxes, insurance, and maintenance. He received $612K in rent, after correcting for management and vacancy.

The loser-renter is sitting at the table with a briefcase full of cash – $737,000 to use round figures.

The member of the landed class has a check for $604,500, but has a $974K hole in his checking account that was obtaining that $604.5K. He is $370K in the hole, and behind our renter by $1.1M.

For our brilliant land investor to reach parity with our cave-dwelling renter, he would have needed to sell his house for $2.22M.

I’m sure you are incredulous at this, but consider that the house was not owner-occupied, so it does not get the cap-gain exemption. He would need to pay taxes on the difference in home prices over the original payment, plus fees and closing costs.

BTW, all of this has taken place against a stable dollar. If you want the inflation, then you have to accept that the dollars you receive in 30 years would be diminished by that amount. If so, it would only be fair to allow the renter a chance to move his investments to capture this inflation. The dollar may deflate, inflate, or stay the same. The same goes for housing prices.

It’s a fool’s game to think that getting paid more dollars that are worth less is a good investment. This is assming what we know, rather than speculating on what might be. It cuts both ways.

Also, this example assumes our landlord lived in his mother’s basement for 30 years. In reality, he would be paying rent or buying his own place, which, as you can see, would only compond his problems.

Thanks for pretending. I am of the opinion that the renter was more than happy to pay his landlord’s rent.

…and as a point of clarification, it would be more accurate to say that I didn’t make the $175K over the past year, but saved $175K. Savings are counted tax-free.

One of the fundamentals of any economic analysis is the “opportunity cost,” as that is the true price of what you are buying. You judge the price of something by what you have to give up to get it. In the case of buying today with the enormous speculative premium, you are giving up the ability to churn those dollars in another vehicle, and deciding that, while we are close to a historic top, that those dollars will continue to outperform other investments.

You will be forced by today’s credit market to leverage much more and are positioned to see increased rental costs through the next 30 years.

I disagree on both of these points, as I have outlined in my original posting and the follow-up comments. I believe that over the next decade that wages will fall in the USA, as well as most of the world. With that, like anything else, the ability of people to afford rising rents will diminish. We have seen an epic expansion in supply of housing units over the past decade, which will be realized when the banks are forced to send their massive REO to market, and builders capitulate and release their stock.

I am also of the opinion (as if it wasn’t obvious over the past 170+ comments) that the speculative premium that exists today will vanish. This will reduce my leverage for housing. Rising interest rates will further push down prices. These rising interest rates will also cause my cash investments to pay more, while people whom “invest” in housing will have thier investment diminish. Remember, housing is leveraged and the first loss comes out of your pocket.

The three examples that illustrated potential problems that I listed in #184 have the very real likelihood of hitting Seattle all at once. We may lose our hegemony over software and bitter water, have our speculative bubble pop, and hit an economic depression all at once.

I wish you well with your investment.

I agree with many things that you say, but you cite isolated incidents. Even now, I would venture to guess that your grandparents property is still worth a lot more.

There are better investments. My point is I am allocating housing dollars towards a choice that has historically had a ROI. You are allocating your housing dollars to something that has absolutely no ROI.

I have leveraged little and am positioned extremely well against future housing costs. You will be forced by today’s credit market to leverage much more and are positioned to see increased rental costs through the next 30 years.

Historically, rents will quadruple over a 30 year period. http://www.census.gov/hhes/www/housing/census/historic/grossrents.html

My point is three-fold:

A city can lose its hegemony over an industry (Detroit)

A speculative bubble may burst (Florida)

A depression may reduce prices (NYC).

Yes, it is likely that your house will have a larger price tag in 30 years, but it is still an illiquid asset and it very well may not beat other, mainstream cash investments over the same period.

The fact that Detroit is not absolutely lower than it was in 1978 is irrelevant. If you had taken the same money in 1978 and gone to cash investments, you would likely be well ahead of your house in gangland.

My grandparents bought their homes in nice neighborhoods over 30 years ago. Today, their homes are surrounded by urban blight.

You should read my post again and understand what it is saying.