Geographic Sales Shifts: South County Gains Back Some Ground

Let’s check in on an update of how the sales volume is breaking down among the different price tier regions around the county. For a more in-depth explanation of the process and reasoning behind this data, hit this post.

As of August, this is where the median prices were for our regions:

  • low end (South Co.): $144,000—$343,250
  • mid range (Seattle / North Co.): $302,000—$573,000
  • high end (Eastside): $400,000—$915,000

It is interesting to note that no NWMLS area had a median above $1,000,000 in August.

The following chart shows the percentage of each month’s closed sales that took place in each of the three regions.

% of Total King Co. SFH Sales by NWMLS Area

Here’s how much of the total sales each of our three regions accounted for in July:

  • low end (South Co.): 32.5% of sales
  • mid range (Seattle / North Co.): 37.6% of sales
  • high end (Eastside): 29.9% of sales

The low-priced region (South King Co.) has been creeping back up the last couple of months. This could be due to the $8,000 tax credit that will expire at the end of November, which is likely much more of an incentive for low-end buyers than for middle or high-end buyers, who are usually not first-time home buyers.

Here’s a close-up of this year’s movement in bar-chart format:

% of Total King Co. SFH Sales by NWMLS Area

It will be interesting to see how long the low-end region gains ground. I suspect that we may see a bit of a spike in November as people move to take advantage of the tax credit at the last minute, but as we move toward the end of the year and into 2010, we will begin to see the low-end sales taper off again, leading to another upward tick in the median price. Meanwhile, I suspect that Case-Shiller may remain mostly flat through the summer, based on the geographic shifts in sales and the reported county-wide median.

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About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market. Tim also hosts the weekly improv comedy sci-fi podcast Dispatches from the Multiverse.

33 comments:

  1. 1
    Kary L. Krismer says:

    I assume you mean no area had a median above $1,000,000. I doubt any “region” ever did.

  2. 2
    The Tim says:

    RE: Kary L. Krismer @ 1 – Yes, sorry. No NWMLS area. I’ll correct that wording.

  3. 3
    deejayoh says:

    Tim –
    I think a stacked bar w/totals to 100% might be a better way to show changes in mix in the second chart. right now the first and second charts are pretty much the same except for time period

  4. 4
    kfhoz says:

    Anecdotal evidence of the tax credit pushing up prices in South King County: I have a friend who just raised her offer on a small house in South King County because she would like to get the $8,000 credit before it expires.

  5. 5

    Using the Tim’s Charts to Decide to Rent or Buy

    I read an interesting article on the pure financial logic to rent or buy. Basically, its better to buy when when rent exceeds 9% of the homes current price; this means rent at $1000/mo barely justifies not buying a $133K home. A $400K home at $1000/mo rent is like getting it for 3%; and is like owning the house with no mortgage and just paying property tax.

  6. 6
    Kary L. Krismer says:

    RE: softwarengineer @ 5 – Well first, you’re assuming that 3% number makes sense. Second, I don’t think any $400,000 houses around here have $1,000 a month property taxes.

  7. 7

    RE: Kary L. Krismer @ 6

    Yes I caught that Anomaly/mo too

    But….if you factor in maintenance, insurance, etc and the fact that all these mandatory homeowners’ fees besides mortgage payments come out of your net pay, $1000/mo to own a $400K home with no mortgage is fairly accurate.

    So, I still found the advice good anyway.

    Oh, AP Polls are out today on the economy. 80% of Americans rate the economy poor. I guess you’re not a Dr Doom for being mainstream American…..but if you’re the other small percent that think the economy is doing well; what would we call that group? Dr. Quack? LOL

    The AP Poll Results:

    http://news.yahoo.com/s/ap/20090914/ap_on_bi_ge/us_meltdown_ap_poll

  8. 8
    Kary L. Krismer says:

    RE: softwarengineer @ 7 – I don’t think the economy is doing well by any means, but I feel a lot better about it than I did a year ago. Now I think there’s only a relatively small chance (<20%) of a total collapse, as opposed to perhaps it being 50/50 a year ago, maybe worse.

    I do think a lot of the doom and gloom is overhyped a bit. Unemployment is only about 50-60% higher than what's fairly typical, but if you just read the text of articles (without stats) and comments of some, you'd think we have 40% unemployment. That said, if you're one of the unemployed, it doesn't really matter if unemployment is 6% or 10%.

  9. 9
    AMS says:

    The Tim-

    I note that your arbitrary divisions of the low-, mid- and high-range have a bit of overlap in the median ranges. In other words, the high end of one overlaps the low end of the other.

    Certainly I appreciate the message you are trying to convey, but there are going to be those areas that are on the edge. These might switch from high to mid, or from mid to low, or the other way around. I certainly appreciate the consistency that you try to maintain, but it is difficult to know for sure that a given area should be in the low or mid.

    CS divides the data by a current sample. In other words, another methodology might be to compute the median for each area individually, excluding the data where samples are too small. Then divide that data into thirds. I claim that the message conveyed will be the same. Let’s start with two data points that will remain unchanged: The bottom of the low and the top of the high range. The other two points will be clearly defined.

    It might be interesting to know how many areas move up among the ranking, similar to market breadth in stocks. In sports some people keep track of how many teams moved up on the rankings, how many moved down, and how many fell off, and so on. Since the number of areas is constant, just giving the data on how many areas moved up from one to the other should be sufficient.

    Taking this approach will allow the data set to adjust to current market conditions. If we assume that all areas are falling, some might be falling faster than others. The market might be mixed, with some areas becoming more desirable, while the demand for other areas wanes. Then there is the possibility that some year all areas are increasing in value, but some areas almost surely will outpace other areas.

    I would also be interested to know the difference in the 33rd percentile price versus the upper bound of the low-range/bottom of the mid-range. Similarly for the 67th percentile.

    Then I would look at historic trends–as always, past performance does not predict future results. If this were the case, then there could be no bubble, and if there were a bubble, it could never burst.

  10. 10
    one eyed man says:

    RE: softwarengineer @ 7

    SE, I agree that in pure economic terms the rent to own math favors renting in King County, at least over the short term. But I think the total costs of taxes, insurance and maintenance on a 400K house are closer to about $600 per month, not $1000, at least assuming its a late model house or in good condition. And in the event our economy, and the real estate market at some point, resume the long term trend of about 2.75% per year inflation, I’m pretty sure owning is the better choice based solely on economics, if you have a holding period of greater than about 10 years.

    Without doing the math other than in my head (I’m too lazy to do the spread sheet and post it) I’m pretty sure that assuming a 2.75% average inflation rate applied to all items including rents and home values, a 5.75% interest rate, 20% down and a gross rent multiplier of 21 at the time of purchase (that’s 250 months times the rent to equal the house price which is fairly common in rental areas of King County) the after tax cost to own is cummulatively less than renting after about 10 or 12 years. I’ve also assumed that the renter puts his 80K available for a down payment in a CD at 3%, the parties are in a 33% tax bracket and the home owner can use the full tax and interest deductions.

    That’s a lot of spread sheet to do in my head so I might be wrong, but I’ve always been pretty good at napkin financial analysis. Unless somebody has the time and the talent to prep a spead sheet to prove I’m wrong, I’m going to continue to believe in my napkin. Of course I used to believe in Santa and the Easter Bunny too so it might not be that big a challenge for anyone who has a good rent vs. own spread sheet that they can run out for 10 to 15 years.

    Obviously, it depends upon your assumptions for maintenance but you can paint a 400K house for less than 5K and it will last 10 years (if the lazy bastard is willing to paint his own garage door once in between) and you can put on a 15K composition roof that will last 25 years. Water heaters, stoves, carpet and furnaces last over 10 years but you could throw in 5K or 6K over 10 yrs for maintenance and to amortize the cost of replacement when needed. Lots of landlords require the tenant to provide their own frig, washer and dryer and lots of home owners do their own interior painting when desired so I wouldn’t include them. In over 20 years of home ownership I’ve never had a plumbing or electrical problem, but I always had homes built after 1980. The sum of taxes and insurance for a 400K home are about $400 per month and the maintenance and repairs (including amortization of items like the roof) are probably about another $200 per month. If your wife wants to remodel because all her friends have granite, travertine and Brazilian cherry, it’s not part of the rent vs own comparison. Anyway, for the kind of money it cost to remodel you should probably do a separate rent vs own comparison, fly to Rio after the dissolution is final and rent some Brazilian cherry of your own. But enough about hardwood.

    If you have a holding period of 10 years, probably the most important single issue is whether you’re in the long term depreciation camp (or at least believe real estate prices will increase on average less than post GD trend inflation of 2.5% or 2.75% per year). As long as King County housing prices are reajusting to fundamental long term values which most Bubble readers would probably agree are closer to prices in the early part of the decade, it doesn’t make sense to buy now based solely on the fact a rent vs own comparison may eventually favor owning after long term inflation and appreciation trends may have returned.

  11. 11
    AMS says:

    RE: one eyed man @ 9

    “And in the event our economy, and the real estate market at some point, resume the long term trend of about 2.75% per year inflation, I’m pretty sure owning is the better choice based solely on economics, if you have a holding period of greater than about 10 years.”

    This is faulty thinking. The basic idea is to either “buy low and sell high” or “buy high and sell even higher.” Don’t “buy during a period of falling prices because sooner or later the market will return.”

    For example, let me remind you I finally received the phone call last year. My friend sold his gold “at a profit.” Yes, that means he must pay taxes, but the problem is that he purchased his gold in 1979. Let’s not mince a year here or there, I call it 30 lost years.

    “I’ve also assumed that the renter puts his 80K available for a down payment in a CD at 3%, the parties are in a 33% tax bracket and the home owner can use the full tax and interest deductions.”

    Again, this is faulty thinking. This has been covered here extensively, but the net cost of capital should be used when discussing rates. It also should be noted that you must give up the standard deduction.

    More problems ahead…

    “and a gross rent multiplier of 21 at the time of purchase (that’s 250 months times the rent to equal the house price which is fairly common in rental areas of King County) the after tax cost to own is cummulatively less than renting after about 10 or 12 years.”

    Yes, the gross rent multiplier of 20 or more is not uncommon. 250 months is closer to 20 years, not 10 to 12 years. (Certainly you cannot suggest that by paying interest you actually gain money!) Also that rent multiplier included the taxes, insurance, maintenance, interest, and so on. Transactional costs related to renting are also lower.

    The only way you can claim to be ahead after 10 to 12 years is high levels of housing price appreciation. If you are right, then you win. If not, you lose. Many fortunes have been lost.

  12. 12
    AMS says:

    RE: softwarengineer @ 5

    Set your expected rate of return. Let’s ignore market value changes for a moment. Let’s also assume zero taxes, insurance, and other operating costs. Let’s go further and assume 100% occupancy.

    A 400k place for 12k in annual rent is just like borrowing 400k at 3%.

    NOTE: As an investor I would RUN AWAY from this as fast as possible. I would never buy a 400k asset to rent for 12k per year. NEVER. My expected rate of return is greater than 3% after realistic expenses, and I have idealized this situation. If we toss in the operating costs, then the percentage quickly approaches zero, and could go negative.

    The larger question is housing price appreciation, possibly negative appreciation (depreciation). There seem to be a large number of people who assume that housing price appreciation is always positive, or will be positive very soon. Using the EMH (Efficient Market Hypothesis) these buyers are willing to pay a premium over those who do not hold the same expectation. As long as the mass psychology keeps bidding the prices up, prices remain high. Mass psychology works in both directions, however. I have owned some great stocks that have not garnered what I believe to be the attention they deserve, and thus the prices were held low for too long.

    If the mass psychology holds out for years, decades, then we can start discussing individual discount rates versus the total market.

  13. 13
    one eyed man says:

    RE: AMS @ 10

    AMS, in your second paragraph, you say that my thinking is faulty because you shouldn’t buy in a falling market. I never said to buy in a falling market. I acknowledged this point in the last paragraph of my comment where I said “it doesn’t make sense to buy now based solely on the fact a rent vs own comparison may eventually favor owning after long term inflation and appreciation trends may have returned.” I agree that it doesn’t make sense to buy in a falling market unless you have reasons other than economic reasons. If it wasn’t clear to you that I don’t advocate “fighting the tape” then let me assure you I agree with you. I just think a lot of Bubble readers lose sight of the fact that on average buying and holding real estate long term has paid off in the 70 years of the post GD era. And this is true even at a high gross rent multiplier of 21 years. It just takes a sufficient inflation rate (about the average of 2.75%), low enough mortgage rate(about the current 5.75% 30 yr rate) and a long enough holding period (about 10 or 12 yrs).

    The comment in your fifth paragraph concerning the cost of capital is merely a different assumption than mine. As I stated in my comment, I assumed the owner has enough other deductions to offset the standard deduction. If that’s not true, then clearly, the math changes and one would have to run the spread sheet with the new assumptions. The interest and taxes in the first year total about 20K so the tax savings is about 6600 if the entire deduction is usable. If only 10K is usable, the tax savings drops to about 3300. Over 10 yrs that change would be worth about 33K in favor of renting. But if the property is appreciating at 2.75% per annum, it takes approximately another 4 yrs of property appreciation to offset the value of the lost deductions under the new assumptions.

    My reference to a gross rent multiplier of 21 as being about average in King County was for the purpose of showing that a rent of $1000 per month as discussed in Softwareengineer’s comment was unrealistic and the true rent for a 400K home in King Co would be more like 400K divided by (21 X 12months) = $1,587 per month. In my experience, a 400K home commonly rents for more like $1,800 but again, it just changes the math a couple of years. The reference in my comment to 10 or 12 years is to my estimate of the number of years it would take before the owner is economically ahead of the renter given the assumptions I’ve stated. If you think it takes longer than 12 years, feel free to run the numbers and post the spread sheet.

    I just ran the numbers again on a piece of scratch paper and found I made a mistake. After 10 years the owner is about 60K ahead given the assumptions I stated. Even if the owner loses the itemized deductions equal to the standard deduction, they are ahead before the end of 10 years.

    If you didn’t do an estimate AMS, just do a non-compounded estimate of the numbers with everything inflating at 2.75%. I’ll post the approximate numbers I ran in the morning if you don’t believe me.

    I’m not forecasting that King County real estate has bottomed or that we will have 2.75% inflation next year, but unlike some others, I wouldn’t rule the possibility of these things out in late 2010 or 2011. The estimate assumes that real estate appreciation and inflation are running at 2.75% per annum. Obviously, Sniglet, Scotsman, Softwareengineer and the other deflation advocates will argue that 2.75% inflation on a long term basis is at best, years away.

  14. 14
    AMS says:

    RE: one eyed man @ 12

    Aside from HPA,

    $400/1.8 = 220 months, or about 18 years.

    Clearly when we add in the other expenses the payback period is well in excess of 18 years.

    As always, you cannot take it with you. Some people spend it on hookers and blow, others spend it on housing.

  15. 15
    David Losh says:

    Real Estate is seperate from inflation. It’s a manipulated market. Land use change, a third runway for the airport or off ramp to the freeway can make or break a location, location, location.

    The biggest issue and one we are seeing here in these graphs are the sales people who are out in force trying to get consumers to sign up for huge amounts mortgage debt.

    Housing units will continue to decline in price until they hit value. Unfortunately the value of Real Estate is declining due to an over supply of cheap housing units. We built thousands of housing units and are continueing to build housing units.

    Places are not renting for the mortgage payments. As land lord resources falter banks will end up with more housing units.

    Banks holding property will be another problem for the housing market. Every empty house represents a non performing investment. It is lost opportunity, it is bad for the economy which puts more downward pressure on the price of housing.

  16. 16
    AMS says:

    RE: David Losh @ 14

    If we took the value of all real estate, which I have never quite figured out how to value, do you think that the value of the entire market tracks inflation over long periods of time?

    Of course we have two problems before we can even answer the question at hand:

    1. How to measure inflation, which has been debated for years. Even a seemingly well-defined system seems to have its problems. The so-called basket of goods method needs to be representative and properly weighted. Then there are the monetarists who count dollars using various measures to determine how much money is in the system without regard to how much anything costs.
    2. How to measure the total value of the housing market, which I have found no good way to do. We value it the same way we do stocks: By the last transaction. If one share sells for $100, then everyone seems to think that they could sell at that same price. This is fine until we have too many sellers…

    Right now I am guessing that the US is experiencing a level of deflation and housing prices are going down…

  17. 17
    David Losh says:

    RE: AMS @ 15

    Real Estate is the return on an investment. Rental income is what you factor.

    If you pay cash for a property what is the return? How much will it rent for? Then you put in the cost to maintain it and what it will sell for as rents continue to rise.

    Since I can remember it took about three years before you could sell a property to break even. That would be about 3% to 4% appreciation per year. Some areas never have appreciation, just the amortization of the loan, other areas had up to 7% appreciation by extraordinary circumstance. Most gains were based on low purchase prices compared to what a property could sell for.

    The real work was attracting high quality tenants no matter what the price. How well you managed or maintained a property determined what kind of tenants you would get. Some rents were really cheap because the condition of the property was poor.

    What we have today is a mess that is getting deeper with each passing month. People bought things that have very low value for premium prices. Kenmore is a good example, Woodinville, the area of 85th and Aurora, Burien, South Everett, Ballard, all these areas have low quality housing units that people have paid prices like they were buying a real house.

    As an example: a builder can put up an apartment building in a few months, rent it out and get a cash flow. Great! No problem. Once you turn around and sell those units, like in a condo conversion, the mortgage payment would need to be what the rent would be for the value to be equitable.

    Will the building go up in value? No. Will the building deteriorate? Absolutely, it was built to have a life span. The dirt is more valuable than the building so in time the building becomes a liability to the value of the lot it sits on. It’s the cash flow and return on investment that makes the building have value.

    It’s frustrating for me that no one gets this. All housing units are not the same. You can have two structures side by side that are completely different. One can have value and the other be a complete and total liability. So data is meaningless unless you have a reference to a specific property.

    That’s where we get the term economic life of a property.

    Some properties become rapidly obsolete. We have a lot of obsolete properties right now.

  18. 18

    RE: David Losh @ 16
    Speaking of Obsolete Properties

    The HUD house next door to me for $110K, then completly remodeled [inside and out, Hades it would of cost us at least $100K to have a carpenter friend do it with our sweat labor too, without license(s)] by the bank’s contractors on the cheap, with a $139K price tag today, still hasn’t sold….I haven’t sniffed inside yet, but I assume it smells like mildew from two past winters with no heat [no amout of paint can cover it up] and the same sheet rock [I asked the contractors, they did not replace the sheet rock….if they did, it would have been better to light a match to it cost-wise].

    I’ll keep the bubble brains informed on this obsolete house.

  19. 19
    AMS says:

    RE: David Losh @ 16

    “If you pay cash for a property what is the return? How much will it rent for?”

    Paying cash is a good place to start the analysis.

    I am going to suggest the annual return on investment follows this basic equation:

    NI/CI [=Net Income/Capital Investment]

    Which is essentially:

    (Annual Rent – Annual Costs)/Cost of property

    Let’s fill it in for the $1,800/month rent on a $400,000 property, as suggested by another above.

    Before expenses:

    (21600-0)/400000 = 5.4%

    Better hope for very low expenses, otherwise that 5.4% will quickly go to zero, or less.

    (Even with very low interest rates, I hope it is obvious that this is a much better deal for the person who is renting–the owner is taking on a lot of risk for very little return.)

  20. 20
    one eyed man says:

    RE: AMS @ 13

    AMS, here are the approximated numbers on the rent v own for the above referenced 400K house in King Co.
    Just so you wouldn’t feel the numbers were unfair, I increased the cost of capital for the buyer’s down payment and closing costs from 3% (a good current CD rate) to 5% which is probably more in tune with rates in a 2.75% inflation environment, but still probably well above normal given that inflation percentage. I also backed out the entire sum of 10 years of standard deductions increased for inflation at the assumed rate of 2.75%. That’s more than fair given that the homeowner likely would have some other itemized deductions to offset at least part of the standard deduction.

    You may disagree that 5.75% interest will be available at anywhere near the bottom of the King County real estate market, but that was the assumption I stated, and given that the Fed and Treasury appear to be intent on saving the financial sector in part by keeping mortgage interest rates low, it is arguably a reasonable assumption that rates will stay low until the real estate market recovers or is very near to recovering.

    The assumptions are generally stated in my prior comments. Unfortunately, I can’t get the column format of the numbers presented below to stay in line when transferring it to the Bubbles comments section so you will have to live with the lack of normal P & L column formating.

    COST TO RENT 400K house for 10 yrs:

    10 years total rent payments beginning at1600/ mo (rent amount
    derived by dividing the 400K purchase price by the approximate
    gross rent multiplier for King Co of 21 yrs) and increased annually
    for inflation at the rate of 2.75% per annum— $220,000

    COSTS TO OWN 400K house for 10 yrs with purchase loan of 320K at 5.75%:

    2% closing costs on 400K purchase price — $ 8,000

    Cost of capital consisting of
    compound interest @ 5% for 10 yrs on 88K down payment
    and closing costs, less annual tax cost of 33% — 35,000

    Interest for 10 yrs on 320K, 30 yr fixed mtg loan @ 5.75% — 170,075

    Value of the 170,000 in interest deductions, less 10 yrs of the standard
    deduction of 11,400 per yr adjusted for inflation at 2.75% per year, @ 33%
    tax bracket
    ten years of interest deductions— 170,000
    ten years of standard deductions — (131,000)
    ————–
    39,000 X 33% = (13,000)

    10 yrs of real estate taxes beginning at 4K/yr, adjusted for inflation— 46,000

    value of itemized deduction of real estate taxes 46K X 33% = (15,333)

    10 yrs of insurance cost beginning at 1,000/yr adjusted for inflation— 11,500

    10 yrs of amortization of maintenance and repair costs estimated
    at $2400/per yr, adjusted for inflation— 27,600
    ————
    TOTAL costs to own for 10 yrs— 270,000

    Sale price of 400K home after 10 yrs
    at 2.75% inflation compounded— 524,600

    less purchase price— (400,000)

    less cost of sale at 8.5% times 524,600— ( 44,600)
    —————
    Less Net Gain on Sale at 10 yrs— (80,000)
    ————-
    Cost of Ownership for 10 years— $190,000

    The Owner realizes a 20K savings in the cost of occupying the $400,000 house after living in the house for 10 years. It doesn’t take huge amounts of annual real estate appreciation to make the cost of ownership less than the cost of renting if the appreciation is sustained for a substantial period of time, like 10 years. Clearly, one can debate a number of the assumptions involve in the above hypothetical. Probably the two most easily challenged are the 5.75% interest rate being available at a time when real estate bottoms, and the likelihood that real estate will appreciate 2.75% or more for a sustained period at any time beginning in the next few years. But given the assumptions stated in comments 9 and 12 above, the owner-occupant financially outperforms the tenant notwithstanding the high gross rent multiplier for King County.

  21. 21
    one eyed man says:

    RE: AMS @ 13

    AMS, here are the approximated numbers on the rent v own for the above referenced 400K house in King Co. So you wouldn’t feel the numbers were unfair, I increased the cost of capital for the buyer’s down payment and closing costs from 3% (a good current CD rate) to 5% which is probably more in tune with rates in a 2.75% inflation environment, but still probably well above normal even with that inflation percentage. I also backed out the entire sum of 10 years of standard deductions increased for inflation at the assumed rate of 2.75%. That’s more than fair given that the homeowner likely would have some other itemized deductions to offset at least part of the standard deduction.

    You may disagree that 5.75% interest will be available at anywhere near the bottom of the King County real estate market, but that was the assumption I stated, and given that the Fed and Treasury appear to be intent on saving the financial sector in part by keeping mortgage interest rates low, it is arguably a reasonable assumption that rates will stay low until the real estate market recovers or is very near to recovery.

    The assumptions are generally stated in my prior comments.

    Sorry, but it appears that the Bubbles comment section won’t retain the column format for the numbers presented below. The numbers were set out in a P & L format such that they line up in columns that have subtotals and totals. In each case, there was a description of a number on the left, followed by the number on the right. The descriptions are sometimes set out on several lines before the number and the number often appears just to the left of the description with no separation. The numbers were lined up in columns well to the right of the descriptions. The horizontal lines were placed below a column to denote a point at which a subtotal was made. The next number after a horizontal line would therefore be a subtotal. It’s probably extremely difficult to read and understand without the formatting, but I’ll post it anyway. My calculation yields a cost to rent of $220K vs a cost to own of $190K after 10 years.

    COST TO RENT 400K house for 10 yrs:

    10 years total rent payments beginning at1600/ mo (rent amount
    derived by dividing the 400K purchase price by the approximate
    gross rent multiplier for King Co of 21 yrs) and increased annually
    for inflation at the rate of 2.75% per annum $220,000

    COSTS TO OWN 400K house for 10 yrs with purchase loan of 320K at 5.75%:

    2% closing costs on 400K purchase price $ 8,000

    Cost of capital consisting of
    compound interest @ 5% for 10 yrs on 88K down payment
    and closing costs, less annual tax cost of 33% 35,000

    Interest for 10 yrs on 320K, 30 yr fixed mtg loan @ 5.75% 170,075

    Value of the 170,000 in interest deductions, less 10 yrs of the
    Standard deduction of 11,400 per yr adjusted for inflation at
    2.75% per year, @ 33 tax bracket
    ten years of interest deductions 170,000
    ten years of standard deductions (131,000)
    ————–
    39,000

    Tax deduction for interest 39,000 X 33% (13,000)

    10 yrs of real estate taxes beginning at 4K/yr, adjusted for inflation 46,000

    value of itemized deduction of real estate taxes 46K X 33% = (15,333)

    10 yrs of insurance cost beginning at 1,000/yr adjusted for inflation 11,500

    10 yrs of amortization of maintenance and repair costs estimated
    at $2400/per yr, adjusted for inflation 27,600
    ————
    TOTAL costs to own for 10 yrs 270,000

    Sale price of 400K home after 10 yrs
    at 2.75% inflation compounded 524,600

    less purchase price (400,000)

    less cost of sale at 8.5% times 524,600 ( 44,600)
    —————
    Net Gain on Sale at 10 yrs (80,000)
    ————-
    Cost of Ownership for 10 years $190,000

    The Owner realizes a 20K savings in the cost of occupying the $400,000 house after living in the house for 10 years. It doesn’t take huge amounts of annual real estate appreciation to make the cost of ownership less than the cost of renting if the appreciation is sustained for a substantial period of time, like 10 years. Clearly, one can debate a number of the assumptions involve in the above hypothetical. Probably the two most easily challenged are the 5.75% interest rate being available at a time when real estate bottoms, and the likelihood that real estate will appreciate 2.75% or more for a sustained period at any time beginning in the next few years. But given the assumptions stated in comments 9 and 12 above, the owner-occupant financially outperforms the tenant inside of a ten year period.

  22. 22
    AMS says:

    RE: one eyed man @ 19

    “My calculation yields a cost to rent of $220K vs a cost to own of $190K after 10 years.”

    If I take this summary as correct, is it really worth $3k/yr to own and accept the risk on a $400k asset? It’s less than 1% per year to shift all the liability to someone else, including job transfers, catastrophic events (such as Katrina), and so on. That said, I will continue on.

    “In each case, there was a description of a number on the left, followed by the number on the right.”

    In general it’s better to structure it the other way around. I understand this is not following the normal convention, but I don’t know of any GAAP rule that says that you must put the text to the left, but I could be wrong. In any event, for online purposes, I always transpose the normal presentation:

    $1000 Revenue
    $ 400 Cost of Revenue
    ——–
    $ 600 Profit.

    That said, I must say this is a mix of data. It’s very difficult to follow what you are doing here. I know that you make different assumptions about the way to handle the taxes, but you have a flaw in the math. The specific flaw is that you are not discounting the tax benefits. You present the tax benefits as an undiscounted amount, which artificially inflates the present value of the benefit. The standard way to handle the tax benefit is to talk in terms of net cost of capital. If the net cost of capital is 5.75%, then we can scratch the entire tax benefit line. Otherwise simply reduce the net cost of capital. When dealing with these low-end loans, the tax benefit is essentially zero, as the standard deduction must be given up. If that is not enough, the tax rates are low enough at the bottom end that the reduction in cost of capital is not significant. A high income earner who is in California with a state income tax, or Oregon for that matter, can benefit greatly from the tax deduction. To start with the tax rate is significant, so the reduction in the cost of capital is worthwhile. Next is that the sheer level of debt load can be significant, so the gross amount is also significant.

    Clearly the tax benefits to landlords are much, much better than to home owners. The question is who gets that tax benefit? The renter? The Landlord? As always, we must assume that there is normal competitive forces in play. So we set the game up: Two seemingly identical properties, except for the owners. Each are rentals, and all the other nice assumptions that need to be made, such as the properties cost the same, have the same maintenance costs, taxes, insurance, blah, blah, blah. There is a differential problem in here, but let’s ignore that to simplify the situation. The one thing that can vary is the amount of the rent charged. Also to simplify matters, only one renter is in the picture. We know the demand is finite, so this is not too egregious. You set your price, and I will simply “share” part of the tax benefit with prospective tenant. I will get the full revenue, and you get nothing. I have stated in the past, there is no way that a landlord in a competitive environment gets to keep the tax benefit, and I stand by that. To maximize the benefit of the tax code, you are always better off renting.

    Then we must deal with that $80,000 in gain. That is realized 10 years from today, so it must be discounted to present value. Unless the discount rate is zero, you cannot suggest that $80,000 ten years from today is worth $80,000 today. It simply does not work that way. This is very similar to the problem with the tax benefit. This sort of flawed finance will get you in big trouble.

    If you could, let’s go this way, which is much more standard in finance.

    Start with Year 1, and state how much you think it costs to rent versus own on a cash flow basis. The rent is easy, but there is a whole host of cash flow problems in home ownership. When do you need that new roof? Furnace? Water heater? and so on.

    Year 1 net cash to rent, net cash to own (Net includes all benefits and such.)
    Year 2 …

    Year 10

    Then we can discount that back to present value today.

    Also we need to deal with the realized opportunity from all the extra cash that the renter has. Certainly you cannot suggest that you will start the owner out with $400,000, but the renter gets nothing. Let’s start the renter out with $400k in cash.

  23. 23
    AMS says:

    RE: one eyed man @ 19

    One more thing to note:

    You have set the situation up in a negative leverage scenario. This should never be done. To make the justification to take the loan out, one must be positively leveraged.

  24. 24
    AMS says:

    RE: one eyed man @ 19

    I don’t know why, but I decided to straighten this all out. Normally I don’t spend this much effort, but it was clear that you did put some effort into the whole thing.

    Summary:

    Home Purchase Price $400k
    $80,000 down payment
    $8,000 closing costs
    i (interest) = 5.75% (interest only note)
    T = 33%
    Housing price appreciation = 2.75%
    Selling price 10 years later = 524,600
    Transactional Costs at sale = 8.5% (transfer costs plus commissions, etc.)

    The initial rent is $19,200 and is increased each year by housing price appreciation.
    The benefit of the standard deduction starts at $3,760 and is increased by housing price appreciation.

    Buy:

    -$98,650 Year 1 (-80,000 down payment – 8,000 closing costs – 12,328 (net interest) – 1,000 insurance – 2,680 Property Taxes )
    For years 2 – 9 it’s basically the same, but no down payment and closing costs.
    -16,000 Years 2-9
    Year 10 we have the sale, but we still have the years 2-9 costs too.
    +$144,000 Year 10 (That is the owner gets a check for $144,000)
    (+524,600 selling price -44,600 trans costs-16,000 year 10 operating -320,000 principal balance)

    Rent:

    -$10,776 Year 1 (-19,200 rent + 3760 standard deduction benefit + 4664 interest on $80,000 (the renter loaned it to the borrower at 5.75%))
    Essentially this continues on for years 2-10, but at the end of year 10 the 80,000 is paid by the borrower back to the lender.

    The renter saves about 6,000 per year, and there was no maintenance included in the owner computations.

    Disclaimer: I did this fairly quick–I am sure there are some small computational errors/compounding issues herein, but the basic presentation is financially sound.

    Clear?

  25. 25
    David Losh says:

    RE: AMS @ 18

    You also need to calculate the vacancy rate at 5%.

    At $400K it makes no sense, there again $1800 a month makes no sense.

    It shows how over priced the housing market is. Rent versus own should be a push. The concern is maintenance. So what people do is cash flow a property and maintain it as a business expense. In the end there may be a profit.

    No matter how you calculate it housing is over priced any way you work the numbers. All Real Estate professionals know that.

  26. 26
    AMS says:

    RE: David Losh @ 23 – Actually I think the rent would have to increase, since we are looking from the renters perspective. The rent amount should be 105% for switching, but the assumption is that the renter will stay in the same place for 10 years.

    This whole thing is crafted up by one eyed man, and in my opinion there are some very unrealistic assumptions. I rented a $600,000 home for $1,650. Here we have a $400,000 home renting for $1,800. Most of the assumptions are weighted to the owner’s benefit. Relax much, and it just gets better and better to rent.

  27. 27
    one eyed man says:

    RE: AMS @ 22

    Your thoughtful analysis and the time that went into it is appreciated. I do however, object to certain items.

    First, although I don’t disagree with the risks of ownership you listed, they are not relevant to the pure financial analysis based solely on the assumed numbers. Furthermore, to the extent that an owner takes on risk, the renter also has risks associated with the costs and inconvenience of being forced to move and the risk that inflation will greatly increase the rent while the owner enjoys the security of a fixed mortgage payment.

    Second, any tax benefit that may be negotiated between a landlord and a tenant is already built into the gross rent multiplier because the gross rent multiplier was set by the market for rents and property prices in the area. As the rent in this hypothetical was determined by the King County market gross rent multiplier, it already takes into account these market forces.

    Third, I had stipulated that all items, including the rent will increase by inflation of 2.75%. The average annual rental is therefore increased by about 15% from 19,200 to 22,080 which increases the renter’s costs by an average of 2,800 per year over the costs you show.

    Fourth, the standard deduction is irrelevant to the renter unless you were just adding it to the renters line items rather than subtracting it from the owners line items. If the standard deduction is being added to the renters, then the owner gets the benefit of the full interest deduction which is (170,000 X 33%) / 10yrs = 5,610. The net interest is therefore 17,000/yr minus 5610/ yr = 11,390. This results in a decrease of the Owners cost by about $1000/yr from the $12,328 you show for net interest.

    Fifth, there are only three groups of items to be reduced to present value. The 88K was incured in yr one so it is already at present value. Because the Owner is being assessed a “cost of capital”, the return of this capital on sale is effectively already reduced to present value. But I disagree with your computation of the cost of capital. The cost of capital for the average home owner or renter is the value of the investment they are foregoing. They are far more likely to invest in a CD at 5% than to make a private loan at 5.75% or any other rate. Furthermore, the true cost of that capital has to be reduced by 33% for the taxes that would be charged on the interest income. This reduces the Owner’s costs by about another 1,500 per year from the 4664 in annual interest you show. The owner’s recurring annual costs exceed those of the renter so reducing these recurring items to a present value will only benefit the owner over the renter, so I chose to ignore them for simplicity as they are close to a wash anyway. I forgot to account for present value for the 80K gain on sale. Assuming a discount rate equal to inflation of 2.75% per annum, the present value of the 80K is about 55K at the end of 10 yrs.

    After these adjustments, including 2400 per year for maintenance, my math still shows the owner ahead of the renter after year 10 by about 24K.

    Obviously, each of us has made calculations on the fly and both of us may have failed to accurately account for certain items such as the time value of money. We can also debate the propriety of the assumptions I stipulated. My point in all of this wasn’t to say that it’s better to buy than to rent. My real point was to dispute the bald assertion often made on the Bubble that a rent v. own analysis is without doubt always in favor of the renter. A relatively average rate of inflation in real estate prices makes leverage over a term of about 10 years a very powerful financial force even in an environment where the gross rent multiplier is as high as 21 years. The benefits of leverage are entirely dependent on real estate price inflation. But even prior to the current Bubble, real estate price inflation at a modest rate was the norm over the last 70 years.

  28. 28

    RE: one eyed man @ 25
    That’s just it, One Eyed Man. History gets ignored and dismissed. A few years ago, real estate cheerleaders were saying things to the effect of ” Real estate has changed. It’s the new paradigm where real estate will only go up from now on, and way beyond the rate of inflation, and you better buy now or else”

    Now, some have the opposite view, something to the effect of ” Anybody who buys a house is a fool. Real Estate has changed and will only go down from now on. Houses are only good to protect you from rain and a place to store ammo, otherwise they’re worthless.”

    There is usually a regression to the mean, and historically, buying a home has been an okay thing to do financially. Not a way to get rich ( although some have) but historically provided slow and steady gains. There have been and will continue to be periods where prices were so high that these slow and steady gains would be impossible, but then they drop, and hold, and rise, and drop, etc.

  29. 29
    AMS says:

    RE: one eyed man @ 25

    Here is the bottom line:

    If the “rent multiplier” is much greater than 150, rent.
    If the rent multiplier is much less than 100, buy.

    There is no way you can support it’s better to buy with a rent multiplier in excess of 200. It’s just not there, unless you have very high housing price appreciation expectations.

  30. 30
    one eyed man says:

    RE: AMS @ 29

    Although I’ve never seen an historical chart of the rent multiplier, I’ve always thought that a multiplier of about 125 or 150 for residential property was the norm, at least until the last decade. But then again, I always thought a CAP rate around 10 was the norm for commercial property until the last decade too. Although I agree in part with your comment on the link between the rent multiplier and real estate appreciation rates, I disagree in part with it for the following reason. Looking at only the rate of appreciation is looking only at the revenue side. You also have to look at the expense side which, for a leveraged buyer, is controlled primarily by the mortgage interest rate.

    The historic average 30 yr interest rate over the last 50 years is about 7.5 percent. The average CPI is about 2.75%. If you do the rent vs own with 7.5% and 2.75%, for 10 yrs, I think you’re right that the break even is a rent multiplier of about 150 (I’m assuming this from history and haven’t actually done the math). But if you bring the real estate appreciation rate up or the mtg interest rate down, the break even rent multiplier is pushed up. There’s probably some commercial spread sheet software out there that could save us the hassle of doing all the math and remembering all the relevant line items, but I don’t know anyone who has a program to just plug the variables into. I’ve got to admit, I’m too lazy to expend the time to do a reliable job that would provide a truly accurate calculation of any given hypothetical. It might be different if we were dealing with real money and not just an intellectual exercise.

    As an aside, we both forgot to account for the cost of capital on the principal paydown on the mortgage which would be another cost to the buyer of about 8K or 10K.

    Just so you know, I’ve never been a big proponentsof taking large risks on the side of buying v. renting. In the mid 1980’s I had to move to the LA area for a period of between 4 and 7 years. I had a cousin there at about the same time. The real estate market was booming and I had to decide whether to rent or buy. I concluded that the risks of buying into a market collapse were too great and rented. I had about 30K in savings to put down on a house in Seattle when my wife and I moved back. The townhome I was lookiing at in So Cal appreciated from about 115K to 175K in 4 years which seemed like a lot at the time. But only until you back out all the costs and discover I would at best have been only about 15K ahead of my savings which were a sure thing.

    My cousin who’s an architect bought a condo in West Hollywood for 125K and sold it 9 mos later for 175K. He bragged to me about his investment prowess and used the proceeds to buy a house in the Valley. Two yrs later in 1990 he got laid off and had to move back to the east coast. The So Cal real estate market turned down at the same time. It took him 3 or 4 years to be able to sell the house in the valley and I think he lost most if not all of the proceeds from the original condo sale.

  31. 31
    AMS says:

    RE: one eyed man @ 30

    The problem that you continue to present is NEGATIVE LEVERAGE. No matter how much non-standard finance you try to create, the fundamental problem remains. If you are going to claim the leverage is good, then you must be POSITIVELY LEVERAGED. Period. That said, we are really comparing two alternatives: rent versus buy. This, I suppose, gets to the whole idea of “throwing money away” by renting. Being negatively leveraged is throwing money away, so I guess the question is which one is throwing away less money.

    Also we should discuss the discount rate of buying versus the mass psychology of holding prices high.

    If you know prices are too high, but you have small children and you seek an “ownership lifestyle,” but you also want to balance basic finance against your lifestyle, what do you do? I have been suggesting that housing has its problems since I sold back in 2000. Yes, I started renting nine years ago. Yes, I did not realize the big opportunity in the bubble, but I didn’t take any bubble risk either. Did I think it would/could go on for about ten years? No. Did I think housing would bring the economy down as much as it has? No. I didn’t quite see it the way it has unfolded.

    That said, you are right that the expense side must be considered when considering the multiplier. The basic assumption I make is that there is an average cost to owning an average home, and that is related to the price. In many areas property taxes are directly related to market value, as measured by some government official…

    Since we have continued this conversation this far, I will run some numbers in the next day. I will try and do a reasonable job. I’ll also give this some more thought.

    Please stay tuned.

  32. 32
    AMS says:

    RE: one eyed man @ 30

    I gave it a shot, but I cannot figure your numbers out. You need to present data so that it is not a confusing mix of this and that.

    Aside from that, I will say one big error is not discounting the $80,000 gain on sale. You have made it clear that you believe this should not be discounted, but this is not sound finance.

    Next time break it down by individual years, and then discount it back to the present at a given discount rate. And yes, that $80,000 gain 10 years later must be discounted back to present value.

    Moving onward, there is plenty of assumption risk in your numbers. A total of $27,600 in maintenance on a ~$475,000 home for 10 years? Crazy.

    I guess we will leave it here: Creating confusing mathematics/finance with unrealistic assumptions is no way to provide further support toward ownership. Some people might be fooled. Simple is better when it comes to presentations of data. Also negative leverage should be avoided.

  33. 33
    one eyed man says:

    RE: AMS @ 32

    AHS, short of someone preping a full spread sheet with explanations of calculations, I doubt that we can resolve our differences of opinion. I do still feel the need to explain a couple things I said that I believe you misunderstood.

    First, I never said that the 80K gain on sale didn’t need to be discounted to present value. I said that the return on sale of the 88K in down payment and closing costs didn’t need to be discounted because it was already subject to reduction to account for the “cost of capital.” At the end of the third to the last paragraph of comment 27, I acknowledged that I forgot to discounted the 80K gn on sale and discounted it to 55K. I used a discount rate of 2.75%, which one might argue to be low in a normal economy, but I think it’s fair given the benefit to the renter from not discounting the recurring annual costs as discussed in the third paragraph below.

    Second, because the comment section didn’t preserve the P & L format of my comment, the limited explanations to my computations became more confusing than helpful. Notwithstanding that fact, I said in the very beginning, I wasn’t going to hand prepare a 10 yr spread sheet with present values etc. and I don’t think it’s necessary in order to come up with a reasonable estimate for the reason stated in the next paragraph. My purpose was to show that given the assumptions I stated, the own v. rent analysis probably turns favorable to the owner at around 10 yrs. The numbers I gave are only estimates. I might have made a material error in calculation or by leaving some material item out, but I’m pretty confident in my ability to give an accurate estimate. As I previously stated, if someone wants to prepare a full spread sheed with explanations for the computations, that’s up to them but I wasn’t going to do it.

    Third, because the recurring expenses were greater for the owner, discounting the recurring expenses to present value over the 10 yrs just helps the case for the owner. Not discounting the recurring expenses to present value is favorable to the renter because the renter’s recurring expenses are less. I therefore chose to not do the present value math for the recurring expenses and accept that it would help the renter and hurt the owner.

    Fourth, the estimate for maintenance expense is reasonable. You can buy a new or nearly new 2000+ sq ft house in Kent, Renton, Maple Valley, Bothell, Kenmore and other communities for about 400K or less. 2400 per yr for the maintenance (including the deferred maintenance like painting in 8 to10 yrs, carpet in 10 to 15 yrs, water heater and furnace in about 15 yrs and a roof in 25 yrs) is not unreasonable for a new or nearly new home. Things like yard maintenance are usually done by the owner if the property is owner occuppied or by the tenant if not. The owner may do more yard maintenance due to pride of ownership but they ordinarily don’t hire a yard service. Most HOA’s are only a couple of hundred dollars a yr or less if there are no common areas other than an entry monument. I’ve always owned homes less than 15 yrs old, and I’ve never had to call a plumber or an electrician. Things like putting in granite, travertine, new flooring and dramatic wall colors aren’t maintenance. If you’re buying a 1940’s Ballard shit box it might be different but my assumption was that you buy a new or near new home with the 400K.

    As I mentioned in my comments, there are two assumptions that I think can reasonably be debated. The first is whether we will see a sustained period of home appreciation at an average rate of 2.75% beginning in the next few years. Second, even though 30 yr interest rates have remained low and 5.75% is currently available, it might not be available when it is reasonable to risk that home prices are at or near a bottom. Over the last 40 or 50 yrs, 30 yr rates have averaged closer to 7.5%, and based upon history, that rate is probably more likely in an environment with sustained home appreciation of 2.75%. The argument in favor of 5.75% being available is that the Fed and Treasury will continue to try to keep rates low until they are sure that the housing sector has improved and the financial sector is no longer at risk of falling back into peril.

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