I finally got around to reviewing this article and I wanted to thank you.
This and the spreadsheet you provided are a great help to people like me that want to explain the complexities of the market to loved ones.

Once more people start to understand the relationships between renting and buying and wages, the market will be forced to correct due to demand expectations.

That being said there are also more properties for rent now because people got caught in the boom/bust and can’t sell so they are renting temprorarly at a negative cash flow until the the inventory is reduced and the market stabilizes. If you click on Tim’s link for Kirkland you will notice that the inventory is trending down and will continue to do so because very little is being built. Next year I would expect to see landlords not renewing the lease for some of these homes and putting them back on the market for sale. That means renters will be forced to move.

The last thing is the tax savings deduction. Tim’s comparison shows that the only deduction that the homeowner would have would be related to his real estate. In fact most people that can afford mortgage payments in the $1,900 range have other deductions against their income such as student loans, capital losses, health savings accounts etc. that they would be able to also deduct by not taking the standard $10,000 deduction. Raising the rent alone to the average price per sq. ft. raises the cost to rent from $1,495.00 (Tim’s cost) to $1,980.00 average cost. ad in additional tax savings, and reduce the rediculously high maintenance cost Tim has and you are paying roughly the same per month to rent as you are to own and there is no garantee that next year you can still rent in the same place at the same price. Tim also has no maintenance in his costs for renting. If you rent a home you are usually responsible for yard maintenance.

I’m confused. If a renter can already deduct 10k, and then they buy the $550k home, they can now deduct 46k (the original 10 plus 30k for the mortgage interest plus 6k for the property tax). If they were previously taking the standard deduction, then buy the $550k house, they were deducting 10k (for the standard deduction), and now they’re deducting 38k at least because of the mortgage interest, property tax, and sales tax.

Also, the “diminishing return” is cancelled out as well, because at the point where the diminishing becomes substantial, you start reaping in the fact that you have a fixed payment whereas rent would have risen.

Whoops, I see that I fat-fingered somewhere between my spreadsheet and the post on the second one, you’re right. That changes the monthly totals by a few hundred, but the 5 and 10-year projections were copied from the spreadsheet correctly.

As far as the interest deduction, Joel described my reasoning accurately. Also it is important to note that this “benefit” diminishes every year of the mortgage. I think it is way overplayed by those in the RE industry.

Also, how do you get $274 tax savings a month on a $2500 mortgage? It looks like you calculated the first example correctly (assuming “less the standard deduction”), but not the 2nd one.

Exactly, what I’m saying is the difference will always be *at least* the interest on the mortgage payments, if the homeowner has no other major tax deductions, because of being able to deduct state income tax and property tax. If the homeowner already can take the standard deduction, if they’re a charitable giver for example, what they can deduct will be the interest on the mortgage payments *plus* the property tax, which would be even more than what I just calculated. (almost $36k a year for the 2nd example, rather than the $20k that tim calculated with)

The other thing that I think is a little strange is that the tax savings are “less the standard deduction”.

If you are comparing renting to buying you need to find the difference in tax savings by buying, not just the absolute savings. If a renter can deduct 10,700 already without buying, but the home buyer can deduct 20,000 then your savings by buying is 9,300 * (tax rate) not 20,000 * (tax rate).

You are spending $1500/month at least to paint the walls. that is the dumbest thing ever. not only do you get to spend money on improvements, you also get to lose the extra rent vs. own money on a depreciating asset. buy hey, you can open up the kitchen into the living room and paint the walls egg shell blue!

Even if a DINC household splits up, they can relatively easily find a new partner…

Where? Do they go to the “partner” store? Makes divorce sound like a piece of cake!

…or take on a roommate.

If I’m in a rental that’s less than 50% of a mortgage, why would I want to pay 50% of someones mortgage to be their roommate?

I agree with your overall point. Comparing average income to asset prices leaves out several factors. For example, it seems to me that prices are in general higher near universities (such as UW) than elsewhere, when I would expect the average income is lower in that kind of area. Part of that is because money is being pumped in from parents from other regions, but that is not income to the students. Another factor is inheritance. Boomers have a lot of siblings so it is not huge yet, but as boomers start to pass on lots of adults will be inheriting fully paid up McMansions.

Sniglet – the benefits guy from Merryl L. came to talk to us in my company. After the presentation I spoke with him about his expectations. He said; short term deflation and high inflation in 5-7 yrs (all the printing of money).

See the proof:

http://finance.yahoo.com/tech-ticker/article/138829/Mortgage-Rates-to-4.5-Percent-Homebuilders-Win-Crisis-Continues?tickers=TOL,HOV,CTX,DHI,LEN,XHB,CTX

He asserts the 4.5% bailout helps no one except the new home builders.

Hades, practically no one in America can afford to retire on like 2-3% money markets or -40% stocks anymore; so let’s lower interest rates some more so the $10/hr lettuce pickers can buy $300K homes.

The American younger generation better wake up and smell the coffee; as these uncontrolled growth clowns make retirement impossible and worsen the credit crisis with more overpopulation credit crisis debt, the college graduates won’t have near as many older generation professional job slots to get hired on anymore. The older workers will just sit in their McMansions, continue working and save forever until they die or get laid off.

You honestly think there’s no benefit to paying a little bit more as a premium for eventual outright ownership?

I am sure those people who bought Tokyo suburban homes in 1994 are thrilled that they paid a premium in order to be “owners”. Those homes are STILL underwater today (by some 40% or more).

I don’t know what a REALATOR is. If you mean realtor, no I’m not. You honestly think there’s no benefit to paying a little bit more (note I said a little, not a stupid over-inflated ridiculous price) as a premium for eventual outright ownership? Is everyone so focused on the short-term? I run into this often on a variety of subjects. Nothing over two years in the past or the future is worthy of consideration anymore.

jon // Dec 3, 2008 at 11:51 pm

“Per Capita income is a better proxy for average salary.”

Household income is the total income of everyone living in the same unit, so it directly reflects the ability to pay the rent or mortgage on that unit. The per capita includes children, who generate no income, and so that number is not useful to understand affordability. Per capita is intended to show poverty levels because kids cost at least as much as adults when you factor in education, etc.

OK, fair enough. That is a fine clarification – but my point still stands. The claim was that homes should go back to “3x the average salary”. This will not happen because it never was the case. Even if you use HHI – which is greater than the average salary (by definition it because it includes all wage earners in home vs. a salary being for one person) that multiple at has not been 3X in KingCo for 15+ years. Using Tim’s data back to 93 shows at that point it was 3.7X and it has only gone up from there. It currently stands at about 6.4x

If you are waiting for home prices to go to 3X average salary you will be waiting for a very long time. That may have been the standard for your Grandpa – but unless he’s willing to part with his house for that amount you are out of luck.

those 4.5% mortgages won’t be around for long

Actually, I think that extremely low mortgage rates will last for several more years at least, and may even go BELOW 4.5%. Using my favourite example of Japan, mortgage rates have stayed at historic lows for 19 years but that hasn’t done anything to goose their real-estate market.

As I mention in my podcast, low rates are NOT an indicator of price appreciation, quite the opposite in fact.

What’s everyone’s projection? Are we looking at a inflationary period which will temporarily “stabilize” housing prices? Or will the US go the way of Japan?

There really isn’t much of a question as to where things are headed anymore. The extremely low interest rates and crashing asset values (particularly commodities) is screaming deflation. If we were going to be headed towards inflation interest rates should be shooting up, and so should commodity prices I(in dollar terms, that is). But the exact OPPOSITE is happening.

What you have to remember is that the global private credit markets have virtually ground to a halt, and all the increases in government stimulus are just a drop in the bucket compared to the size of the credit markets that have ceased to function. When you take away 70% or 80% of the world’s money creation away (which is what the private credit markets represented in the last decade), there is no alternative but deflation.

I have a link to an excellent chart showing the historical relationship to commodity prices and the economy at http://www.surkan.com. It clearly shows that massive commodity price crashes correspond with periods of economic contraction and deflation. Scarier, this year’s crash in commodity prices is one of the most severe on record.

Calculated Risk points out that you also need to consider if you will have a buyer when it comes time to sell, and those 4.5% mortgages won’t be around for long. If too many people take advantage of that, it could be a repeat easy-money bubble.

However, because inventories are headed down and many locations are below replacement cost, I think prices will stabilize within a year or so. It may be a time to take advantage of some good deals. You just have to make sure that if you buy that it is not in a market segment that is still in over-supply.

2. If you live in Kirkland and quit your job to get a lower paying job to get loan modification I think you are fooling yourself. I highly doubt the described modifications (38% debt to income ) are or ever will be for $500k an upwards homes. I would also be suprised if there isn’t some sort of limit on the difference in income vs debt to qualify where a big diff will be a disqualifier.

3. Whatever the gov do will likely target to stem the national foreclosure rate. The median national home is something just north of $200k. I think King Co. home onwers will be out of luck.

I have to say that I’m a bubble believer but if they somehow get rates down to 4.5% I will start looking again. Not necessarily buy, but look.

Actually, if rates get down to 4.5% you should RUN away from real estate (and virtually every other asset) as fast as possible! Low rates are a sign of deflation, and indicate that asset prices are going to keep falling. Paradoxically, a significant rise in rates (to 7%, say) would actually be a good signal that deflation was over and that prices were going to start appreciating again.

I have a podcast on exactly this subject (i.e. why low rates are something to be frightened about) at http://msurkan.podbean.com.

Also to what extent can the US look out for help from foreign countries. For example China will be in a big predicament if US consumers retreat and don’t buy the toys they are producing. So China and many other countries would be willing to do all kinds of bailouts because this will ultimately help develop their economies.

The Chinese and their fellow BRIC countries seem to be busy cashing out of the dollar so that they can spend on infrastructure growth in their own economies. They need immediate impact for their expenditures. (Otherwise, they’ll face mass social unrest.) Take a look at the following blog from the Financial Times.

What’s everyone’s projection? Are we looking at a inflationary period which will temporarily “stabilize” housing prices? Or will the US go the way of Japan? Or worse, because the Japanese at least had the trillions of private savings and a trade surplus… while the US has trillions of debt and a gaping trade deficit.

My friend who works at MSFT is already trying to figure out a strategy to siphon some of the cash that will be flowing around once Obama puts the economy into higher spending gear.

Sure, it is always possible to feed at the government trough, but that doesn’t mean that the over-all economy or real-estate market will improve due to government spending. As I mentioned earlier, Japan’s government pumped masses of stimulus into the economy, just as the US did in the 1930s. In both cases the people who got contracts for large public works projects did very well, but the broader economy actually suffered as capital was redirected from the private sector into governmental boondoggles.

I’ll say it again: the government is utterly powerless to prevent real-estate (or any other prices) from crashing even more as we enter this deflationary cycle. Whatever spending the government does undertake will only make things worse (i.e. by siphoning money from somewhere else where it would be better deployed).

What do you think about going off a recent sale so you know what the price closed at? I don’t think it will change the outcome much, but would probably be a little more realistic.

At what point will the govt help to sustain the prices?

For example if the govt offered to pay for half of all outstanding loans – the prices would for sure go up. The issue would be how to get the money? Some people think that printing money would equal more damage because the value of the USD would just suddenly fall off a steep cliff. The question where is the equiliribium?

Also to what extent can the US look out for help from foreign countries. For example China will be in a big predicament if US consumers retreat and don’t buy the toys they are producing. So China and many other countries would be willing to do all kinds of bailouts because this will ultimately help develop their economies. Could this type of help – work its way into the system and somehow bailout all irresponsible homeowners?

Obama is a democrat who probably believes in socialist – European type policies that stifle growth in the long term but could fix things in the short term. He could try to put the US into more unsustainable debt to cover up the fact that there needs to be lots of changes. Lots of poor people voted for him and they are all for govt bailouts.

My friend who works at MSFT is already trying to figure out a strategy to siphon some of the cash that will be flowing around once Obama puts the economy into higher spending gear.

With the exception of a roof and of course remodeling, it is normally a lot of time and a few bucks on a regular basis. I had to spend $850 on a water heater one time and one of my landlords did the same.

My homes were/are taken care properly.

I agree, 5.75% is a sort of high interest rate to use in this calculation. The other thing that I think is a little strange is that the tax savings are “less the standard deduction”. Who only takes the standard deduction?? At the very least you can assume that for someone paying, in the 2nd example, $2,568 a month in mortgage payments, is paying less than 37% of their income as mortgage.

At $83,286, they would be at least be able to deduct around $1465 for state income tax. (20% of gross income * local tax rate of 8.8% – where I live, anyway) Also, assuming the average charitable giving rate of 2.2%, that’s another $1826. Plus, you can deduct the property tax of $6324.

That’s nearly the standard deduction for married filing jointly right there. ($9615) Plus, I’m sure the average person has at least something else they can deduct. (Tax paid for car license, maybe some of their housing repairs count as home improvement, some kind of other tax shelter…)

I think it’s safer to assume that the mortgage interest is entirely deductible, which would make the tax savings $642 a month…much higher than $274.

Also, keep in mind that the government is demanding that lenders tighten lending standards at the very same time it is trying to boost lendning. The FDIC, for example, has passed rules that make it nearly impossible for developers to get loans these days. Numerous efforts are also under way in Congress, and various regulatory agencies, to prevent banks from returning to the loose lending practices of the bubble.

Lastly, in a deteriorating economy, more people will find their credit becomes sub-par as they lose jobs, take pay cuts, etc.

Lower mortgage rates wont help very much when the pool of possible borrowers keeps shrinking.

Just another reminder that my podcasts cover some of these deflationary phenonmena at http://msurkan.podbean.com.

I think the discussion does not talk about the fact that the govt is likely to go on a rampage and try to inflate the house prices.

Certainly the government WILL do anything and everything it can to boost house prices, and flood the economy with stimulus. In the end, however, it won’t do any good. Interest rates are already at historic lows but that doesn’t seem to be goosing the housing market. Pushing rates even lower won’t help. Japan pushed interest rates to zero in the 1990s to no avail, and all the latest government stimulus attempts will fail abysmally too.

Who wants to borrow a pile of money, even at zero percent, to buy an asset that is depreciating? I’ve read articles about people who bought homes in Tokyo suburbs in 1994, after they had fallen some 30% or 40% in value, only to see them drop another 40% in the coming decade. Those low interest loans they got still need to be repaid. I am sure those Tokyo home buyers would have much preferred buying their homes at triple the interest rate if they could have gotten them at the ultimate bottom in price (which still might not have been hit, by the way, since the Japanese economy is tanking again).

I have written about this deflationary trend, and why the government is unable to do anything about it, at my blog at http://www.surkan.com.

And then just cruize the Carribean etc.

My friend in Kirkland is already thinking of quiting his job for a while, missing some payments to get free handouts from the govt. Nobody is writing about loopholes on how to get a free ride here.

Here is an excerpt:
“Here’s how the plan works: A homeowner who lives in a house and misses at least three loan payments can qualify for a streamlined workout designed to reduce the monthly payment to a 38 percent debt-to-income ratio. (Principal, interest, taxes, and insurance would be no more than 38 percent of gross income.) The plan initially targets 40,000 mortgages.

To make that happen, the FDIC is extending the term of the loan to 40 years; lowering the interest rate permanently; lowering the interest rate as low as 3 percent for up to 5 years; or excluding part of the loan balance when calculating the monthly payment. (In the latter instance, the amount owed would not change and the borrower would have to pay it back when he sells or refinances.) The workout can also include some combination of the above.

Here’s how the law of unintended consequences could work in this scenario:

1. The struggling homeowner who scrimps and saves to make the mortgage payment stops paying for three months in order to qualify for a workout.

2. The borrower reduces his household income; if unemployed, he stops looking for work or takes a low-paying job temporarily (barista at Starbucks, for example). A two-income family would have one of the wage-earners quit and stay home with the kids. Once the mortgage has been adjusted based on the lower income and set for five years, the borrowers seek new jobs (or second incomes), ideally with higher wages.”
from:
http://finance.yahoo.com/expert/article/moneyhappy/126560

Lots of people bash me when I say the govt is going to do everything to inflate the prices, get into more debt to finance current debt and will just go on a complete rampage to save the system as it is. I think I am correct. I am starting to doubt there will be deflation. But who knows.

One step at a time! We still need to convince our “spend happy” state and local government officials that there’s been a crash before we can started thinking about a turn around.

Household income is the total income of everyone living in the same unit, so it directly reflects the ability to pay the rent or mortgage on that unit. The per capita includes children, who generate no income, and so that number is not useful to understand affordability. Per capita is intended to show poverty levels because kids cost at least as much as adults when you factor in education, etc.

Another Tim at 17 “There are other benefits to ownership than getting a good ROI. Even in light of government control of what used to be “property rights” you can still add on to the building and/or make other changes of your own desire without having to consult a landlord. It’s not always about the money.”

YOU HAVE TO BE A REALATOR I mean that is classic — “It’s not always about the money.” — Are you serious?????

I think I have a challenge to those of you so inclined. Listen – the crash was easy to predict – I think we can all agree on that. My question to you is this – when will the bottom be here? When will you captialize on the bottom? I think that discussion is a much more interesting conversation at this point – since it is certainly the harder question to answer. Not talking about the turn around means you are really just cheerleading the crash isn’t it? I’m not judging – don’t think that – but more curious than anything.

Thoughts?
Dave

and by that measure, Seattle has been at around 6x multiple for the better part of 20 years and is currently around 8

http://img132.imageshack.us/my.php?image=housetopcihs8.png

The bulk of the Bubbleheads wouldn’t touch real estate with a 10 ft pole right now… this thought is starting to become mainstream as well.

The sellers (who actually need to sell) are very clear on this at this point, mind you. The rest of the sellers are dreaming.

I think it’s between 3 and 4 percent.

click here

Prices for any property must conform to historical models of 3x the average salary, period. Anyone calling a bottom now or in the next year is delusional or lying.

Please point me to the time that housing was “3x the average salary”. That is an old wives tale.

Prices will drop for both rental and SFH properties to levels not seen in decades.

Anyone buying post-2000 will know they paid far too much.

Prices for any property must conform to historical models of 3x the average salary, period. Anyone calling a bottom now or in the next year is delusional or lying.

Good luck to all and a happy holiday season.

Don’t CLUMP me in your basket of 30k friends at the NWMLS. Most want nothing to do with me.

My wife and I just had our lease expire and are going to shoot for getting a new year long lease at a lower rate.