Socializing Bad Investments

[helene_t]

I totally disagree with Winston blaming America, our country has its own people to blame, Demark has its own people to blame< germany has its own people to blame

You bloody traitor. Go sit in the corner, facing the wall, and write this text

All our misery comes from the USA. Americans are evil. We Europeans are morally superior

over 100 times. Not until you've done it you can return to the forum ;)

[kenberg]

I totally disagree with Winston blaming America, our country has its own people to blame, Demark has its own people to blame< germany has its own people to blame

 

Imigration, buy to let, the EU, also sorts of factors, I really just do not buy that US have *****ed us all over, we have made our own mess of things, all this was foreseeable, no one wanted to listen and they were all scared money would be diverted from them selves to go and earn these manic returns somewhere else

 

If you want to blame someone.. Blame MR Greedy bastard

Yes, but there will always be Greed Bastards. Perhaps I am a Greedy Bastard. The challenge is to design the system so that it works reasonably well even given the existence of Greedy Bastards.

 

Greedy Bastards depend upon the existence of Gullible Fools, another species that will always be with us. Again, policy has to deal with this. Here is a thought. A couple of years back the bankruptcy laws were changed. A bad idea, I thought. The laws as they were put some restraint on the GBs. If they talked a GF into a stupid debt, there was always the out of bankruptcy. This put some restraint on the GB to not give totally ridiculous loans to the GF. Of course the current scenario has the GBs threatening to crash the economy if we don't bail them out of their stupid loans. A resourceful lot, those GBs.

[Winstonm]

There is a real debate if bubbles even exist, this includes the famous tulip bulb craze. Tough to define the cause if they do not exist.  Of course there is always volatility in finance, 100% of every day

.

 

I agree. I am aware of this debate. The term bubble is difficult to quantify. It is most likely a lazy term applied too frequently. Barry Ritholtz, managing partner of Ritholtz Research and Associates, would agree with you - he has stated that a bubble should have little-to-no underlying value, i.e., the internet bubble where valuations were collateralized by hand-socks.

 

"The losses of value will of course by assymetrical - areas that had the most ficticious appreciation will have the most loss, like California, Nevada, Colorado, Florida, and Arizona - while some areas may remain relatively stable. But those stable area would be those that had the least price appriciation or had price appreciation caused by qualified supply"

 

 

This is a big assumption. Those who loan money may not live where those who borrow money live, too big an assumption. Example, Germany loaned money to Calif. Calif cannot repay bonds, owners in Germany hurt.

 

I was talking only about the loss of wealth effect to the homeowner. Housing prices will fall further in the states mentioned than some other states. I was not talking about the losses to the lenders.

 

In any case I think you misuse the word assymetrical here.

 

Quite possible - it was late. :)

 

In any case what problem are you trying to solve, risk of life?

 

No, risk of contagion to the healthy.

 

You might also comment on this, Mike. I have been considering a hypothesis that the lowering of interest rates to stimulate borrowing in housing only accomplishes a compression of economic time. In the housing mania, for example, future buyers were lured into present-day activity due to an artificial inducement, i.e., lowered borrowing costs. But in actuality, all that has been done was to compress some number of future years growth into a lesser number of years - say, 20 years of historical growth compressed into 7 years. Not only does this affect economic activity, but it also creates a demand/supply imbalance that drives up prices. When a high percentage of future buyers have acted, or when interest rates are sufficiently raised, the driving mechanism of compression fails. Having borrowed future economic activity, when the future arrives there are fewer actors and thus a reversion to mean occurs, invariably an overshoot to the downside below the mean.

 

In this sense expansion is artificial, as it has really only been time-compression. At the end, having lured the preponderance of future qualified economic actors to change their time preference, demand slows and can only be replaced by non-qualified actors - estimates claim that 25% of all home loans in 2005 and 2006 were high risk.

 

Charts of U.S. home prices give this impression - a huge bulge from the mean in the years 2000-2007.

[hrothgar]

There is a real debate if bubbles even exist, this includes the famous tulip bulb craze. Tough to define the cause if they do not exist.  Of course there is always volatility in finance, 100% of every day

.

 

I agree. I am aware of this debate. The term bubble is difficult to quantify. It is most likely a lazy term applied too frequently. Barry Ritholtz, managing partner of Ritholtz Research and Associates, would agree with you - he has stated that a bubble should have little-to-no underlying value, i.e., the internet bubble where valuations were collateralized by hand-socks.

This strikes me as a pretty meaningless distinction:

 

Let's take real estate as an example: Ritholtz would seem to say the following

 

Real Estate has intrinsic value, therefore its inappropriate model the real estate market as a bubble

 

I would claim that the value of real estate is characterized by both an intrinsic component and a speculative component. Ideally, we should be able to disaggregate the two components and model each one separately (allowing for certain cross effects)

 

Yes, this difficult (deservedly so). This is why the quants on Wall Street earn the big bucks...

 

Please note: Part of what makes this all really ugly is the fact that good predictive models become obsolete as soon as they become well known. Lets assume that I developed a model that was accuately able to describe the stock market. If this model were to "leak" everyone would start trading on it, the P/E ratios wiould all adjust and my model would stop providing any alpha...

 

In effect, the nice simple little market that I was able to describe has disappeared and been replaced with something more complex

 

(BTW, for what its worth, I think that its a mistake to provide much in the way of bailouts. Sorry if folks screwed up, but you can't spend your days gambling at the casino and then go running to daddy asking him to cover all your losses when something goes South)

[helene_t]

I hope you do not advocate that people who loan money take all the risk and those who borrow assume none?

I do (assuming we are talking about the risk related to overall housing prices only). Home owners are primarily interested in a place to live. They may not have any capital, let alone risk-willing capital. In particular they may not be interested in taking risks for borrowed money. Also they may have insufficient knowledge about the housing market to assess the risk they are taking. Or the time horizon they want for their investment may be different from the time they want to live in an owned house.

 

Therefore it would be beneficial for some home owners if there was an efficient market for house-market-futures, where they could buy off the part of the risk of their investment that is related to future house market perturbations.

 

Of course some home owners do have risk willing capital. Fine. They would not need my system but could just do it the existing way, thereby saving the risk premium and overhead.

 

Not sure why the financial sector has not come up with something like this by itself. Maybe there is a flaw in my thinking. Or maybe the financial sector is just conservative.

[Winstonm]

Helene,

 

I'm unclear whether or not this would do the trick. The U.S. housing problem is one of owner solvency - the solvency issue created the oversupply in available houses (As of today, 10.3 months supply of houses are on the market.) This is siimply supply/demand inbalance at this point, causing falling prices.

 

Also, there have been in place mechanisms to manage bondholder's risks via the Credit Default Swap, or CDS. This is basically an insurance policy to offload the risk to a second party, who takes a fee.

 

The real crux of the entire fiasco is that the models used assumed steadily rising home prices. In a conference call a couple of years ago, I believe it was Fitch, was asked point blank what would happen to their model if home prices fell 1-2%.

 

The answer was a rather prescient: The model would fail.

[mike777]

I hope you do not advocate that people who loan money take all the risk and those who borrow assume none?

I do (assuming we are talking about the risk related to overall housing prices only). Home owners are primarily interested in a place to live. They may not have any capital, let alone risk-willing capital. In particular they may not be interested in taking risks for borrowed money. Also they may have insufficient knowledge about the housing market to assess the risk they are taking. Or the time horizon they want for their investment may be different from the time they want to live in an owned house.

 

Therefore it would be beneficial for some home owners if there was an efficient market for house-market-futures, where they could buy off the part of the risk of their investment that is related to future house market perturbations.

 

Of course some home owners do have risk willing capital. Fine. They would not need my system but could just do it the existing way, thereby saving the risk premium and overhead.

 

Not sure why the financial sector has not come up with something like this by itself. Maybe there is a flaw in my thinking. Or maybe the financial sector is just conservative.

Helene:

 

I am still not exactly sure what you are advocating but let me take a stab. :)

 

You want a financial instrument that hedges the risk of your house going down in price, correct?

 

One way now is that you can gift your house but have the right to live in it the rest of your life. Now you have a roof over your head and your house can fall to zero, no problem. I assume the house is paid off and you got a roof over your head.

 

Or you can sell your house or reverse mortagage it but have the right to live in it the rest of your life.

 

Of course you need to somehow work out who pays the real estate taxes, and cost of maintence of the house.

 

Bottom line if you do not want the risk of ownership you need to transfer that risk or the PV of the house to someone else...you can right now. :)

 

I do disagree with your basic premise though....It seems the mantra I have heard for over 50 years is "buy a house, build equity" NOT...buy a house have a roof over your head. :)

[mike777]

"The real crux of the entire fiasco is that the models used assumed steadily rising home prices. In a conference call a couple of years ago, I believe it was Fitch, was asked point blank what would happen to their model if home prices fell 1-2%."

 

Lets back up a second. Fitch, Moodys, Standand and Poor are in the opinion business. If you want to borrow money, you pay the opinion business to give you a rating. Let me repeat this, it is the ones who want to borrow the money who pay for the opinion, not the ones who are going to loan the money. :)

 

I pay my neighbor to say I am a good credit risk, now please loan me millions. My neighbor says sure pay me thousands and I will issue an opinion you are an AAA good guy.....and you believe it...nice racket ehhhh :)

 

Now whose fault is it, my neighbor.....mine for paying him or hmm you? :)

[Winstonm]

Lets back up a second. Fitch, Moodys, Standand and Poor are in the opinion business.

 

I would call it opinion racket - but that's another debate. :)

 

I only used the Fitch conference call as that is the only one I have personally read, but the point I was trying to make is that eveyone bought into flawed models - buyers, sellers, lenders, originators, appraisers, securities dealers.....and the all the models - not just Fitch's - said home prices only go one way - up.

 

It seems the mantra I have heard for over 50 years is "buy a house, build equity" NOT...buy a house have a roof over your head.

 

Maybe not quite that long, but surely two generations had been convinced that home prices only go up.

 

I like your idea better - have a roof over you head. If only that had been the mantra we would not be in this fix.

[hrothgar]

I do disagree with your basic premise though....It seems the mantra I have heard for over 50 years is "buy a house, build equity" NOT...buy a house have a roof over your head. :)

Comment 1: I think that the old "Buy a house build equity" theory largely reflected the fact that most people didn't have good alternative investment vehicles

 

Comment 2: I just did a fairly serious cost / benefit analysis studying whether or not it makes sense to buy a house or continue to rent an apartment. Rent turned out to be the overwhelming favorite.

 

Rent now, I'm renting a very nice two bedroom apartment for about 1200 a month. I have plenty of space in a nice town and I'm walking distance to work and the commuter rail lines. I always heard that you shouldn't buy unless the home price is roughly 100 times your monthly rent. I'd have to pay 500K for anything comperable.

 

Maybe rental prices in the Boston market are still artifically low compared to home prices; however, even with all the various savings associated with home ownership its still a lot better to sock away 50 grand a year into mutual funds rather than paying down a mortgage, paying real estate taxes, homeowner's insurance, and either (condo fees or maintenance). I rather be making interest than paying it to someone else.

 

Yes, houses are nice. Yes its nice not to worry about capital gains. Even so, over 25 years the stock market will typically outperform the Real Estate market 4:1. Moreover, if I do decide that the real estate market has bottomed out, I can always start investing cash into real estate funds...

[mike777]

Ralph Nader who is running for President has a plan.

 

Tax speculation, much much more. Tax labor or food, much much less.

That sounds like a good first step to stop those Greedy B.

 

IF we can get rid of or at least slow down/make it very very difficult for those Greedy B who are just in this to make money or speculate that will help. And if they do make alot of money.....tax the heck out of them.

 

Denmark, the happiest place in the world, pays people to go to school, they pay them to stay home with their young children.

 

In the USA we make people pay to go to school or make them pay for childcare.

[sceptic]

I wonder if anyone thinks that one family one home is a good thing and houses are not investments they are for people to live in not make money out of

[mike777]

I wonder if anyone thinks that one family one home is a good thing and houses are not investments they are for people to live in not make money out of

I wonder if anyone thinks apartments are places to live in and a good thing and not investments to make money out of.

 

One way to stop having people stop thinking of their house as an investment is to let the bank get all the appreciation or depreciation. Of course you still own the house so that means you must pay for the taxes, interest, water, sewer, garbage pickup, insurance and upkeep, cut the lawn, fix the roof, fix the pipes, etc or the bank gets the house back now for free and you are out in the street. Local schools, teachers, books, buildings are paid for by the local home owners, so you still got to pay for all of that even if you have no children yourself. About every ten to twelve years you got to rip out the furnace and aircond. Let's assume that costs around 20k or more. You can put in your own numbers on the upkeep of a house. :)

[mike777]

I do disagree with your basic premise though....It seems the mantra I have heard for over 50 years is "buy a house, build equity" NOT...buy a house have a roof over your head. :)

Comment 1: I think that the old "Buy a house build equity" theory largely reflected the fact that most people didn't have good alternative investment vehicles

 

Comment 2: I just did a fairly serious cost / benefit analysis studying whether or not it makes sense to buy a house or continue to rent an apartment. Rent turned out to be the overwhelming favorite.

 

Rent now, I'm renting a very nice two bedroom apartment for about 1200 a month. I have plenty of space in a nice town and I'm walking distance to work and the commuter rail lines. I always heard that you shouldn't buy unless the home price is roughly 100 times your monthly rent. I'd have to pay 500K for anything comperable.

 

Maybe rental prices in the Boston market are still artifically low compared to home prices; however, even with all the various savings associated with home ownership its still a lot better to sock away 50 grand a year into mutual funds rather than paying down a mortgage, paying real estate taxes, homeowner's insurance, and either (condo fees or maintenance). I rather be making interest than paying it to someone else.

 

Yes, houses are nice. Yes its nice not to worry about capital gains. Even so, over 25 years the stock market will typically outperform the Real Estate market 4:1. Moreover, if I do decide that the real estate market has bottomed out, I can always start investing cash into real estate funds...

Yes, our family and people they work with refused an offer to relocate to Boston just a couple of years ago. I love Boston and there are alot of great reasons to live there. I do note that the Boss of my spouse is located there and she has to fly up there all the time.

Housing costs is not one. :)

 

I do note someone is trying to build up equity/make a profit/speculate by owning your apartment/home. Just not you. Of course they may fail. IF they fail we can only hope the government steps in and helps them, saves them due to some social contract or something like that. :)

 

Not so funny is that for some renters, if the real estate owner goes bankrupt the bond owner may be able to force you the renter out in the street, even if you made all your rent payments on time. :)

 

As I listed in my post above, most people never factor in just how much the "cost" of a house really is. :)

[kenberg]

I don't doubt that the shrewd investor can do better in the stock market. But:

A. I am not a shrewd investor in stocks.

B. I don't have the personality to become a shrewd investor. I get bored easily with such things. I am not saying they are intrinsically boring, just that I get bored.

 

I am 69, I own my home. I plan to live in it for the foreseeable future. No rent. No mortgage. I would call this an investment that has worked out. I have some other investments. I can't quite remember what they are, but I have some stuff about them around here somewhere. These, as you might expect, aren't doing so well. Or at least I don't think they are. Maybe I should look.

 

We all have to know who we are. I would lose my shirt trying to play Warren Buffet. I'm closer to Jimmy Buffet.

 

Ken

[Winstonm]

We all have to know who we are. I would lose my shirt trying to play Warren Buffet. I'm closer to Jimmy Buffet.

 

No problem Ken. Home prices in Marguaritaville are holding up quite well - from what I can see - they're a little blurry - now where did I put that shaker of salt?

[helene_t]

Bottom line if you do not want the risk of ownership you need to transfer that risk or the PV of the house to someone else...you can right now.

Yes but people tend to live in the house they own, for obvious reasons. They want to be able to make modifications to the house they live in without having to ask a landlord. They want to the increase in value of the house, which comes from their good care for their house, to go to themselves, not to the landlord. They don't want to pay for the overhead associated with renting.

 

I propose a mechanism that would allow homeowners to keep those advantages without being forced to face the risk associated with fluctuations in the overall house prices.

[1eyedjack]

Comment 2: I just did a fairly serious cost / benefit analysis studying whether or not it makes sense to buy a house or continue to rent an apartment. Rent turned out to be the overwhelming favorite.

 

Rent now, I'm renting a very nice two bedroom apartment for about 1200 a month. I have plenty of space in a nice town and I'm walking distance to work and the commuter rail lines. I always heard that you shouldn't buy unless the home price is roughly 100 times your monthly rent. I'd have to pay 500K for anything comperable.

 

Maybe rental prices in the Boston market are still artifically low compared to home prices; however, even with all the various savings associated with home ownership its still a lot better to sock away 50 grand a year into mutual funds rather than paying down a mortgage, paying real estate taxes, homeowner's insurance, and either (condo fees or maintenance). I rather be making interest than paying it to someone else.

 

Yes, houses are nice. Yes its nice not to worry about capital gains. Even so, over 25 years the stock market will typically outperform the Real Estate market 4:1. Moreover, if I do decide that the real estate market has bottomed out, I can always start investing cash into real estate funds...

I have no information from which to dispute what you say, but I find it surprising (I find lots of things surprising, mind), and it is at odds with my understanding of the general perception, although my general perception may be coloured by local property market trends. I expect that you calculated the expected return on the stock market by the rise in the index, akin to sticking a pin on the dartboard as an investment policy. Likewise I expect that you calculated the expected return on real estate by a rise in global property prices over a period. A particular individual who is considering this equation in relation to his personal affairs is unlikely to apply so random a policy to either medium. The attitude of the consumer to risk may also be a factor. Traditionally the equity market is regarded as a higher risk investment medium than the property market. If you limit the population of equity products to those with a comparable degree of risk you may find that the expected return drops to something more closely resembling that of the property market.

 

I look at it in possibly overly simplistic terms: In any financial transaction, cutting out the middle-man is usually the winning option for the purchaser and vendor alike, the only loser being the middle-man excluded from the transaction whose profit foregone can then be shared between the remaining end parties. Taking this analogy to the property market, in order for a tenancy to exist there has to be a landlord. The landlord expects a return on his investment, which will come in part from an expected rise in property prices and in part from rental income. The landlord will have done his own sums to determine that the expected return is sufficient to make it worthwhile for him to be a landlord. That return is at least in part at the expense of the tenant. In this regard the landlord is akin to the middle-man, the exclusion of which would be of benefit to the prospective freeholder. Without doing any sums or market analysis, therefore, I would expect the outright purchase to be the winning option.

[hrothgar]

I have no information from which to dispute what you say, but I find it surprising (I find lots of things surprising, mind), and it is at odds with my understanding of the general perception, although my general perception may be coloured by local property market trends. I expect that you calculated the expected return on the stock market by the rise in the index, akin to sticking a pin on the dartboard as an investment policy. Likewise I expect that you calculated the expected return on real estate by a rise in global property prices over a period. A particular individual who is considering this equation in relation to his personal affairs is unlikely to apply so random a policy to either medium. The attitude of the consumer to risk may also be a factor. Traditionally the equity market is regarded as a higher risk investment medium than the property market. If you limit the population of equity products to those with a comparable degree of risk you may find that the expected return drops to something more closely resembling that of the property market.

 

I look at it in possibly overly simplistic terms: In any financial transaction, cutting out the middle-man is usually the winning option for the purchaser and vendor alike, the only loser being the middle-man excluded from the transaction whose profit foregone can then be shared between the remaining end parties. Taking this analogy to the property market, in order for a tenancy to exist there has to be a landlord. The landlord expects a return on his investment, which will come in part from an expected rise in property prices and in part from rental income. The landlord will have done his own sums to determine that the expected return is sufficient to make it worthwhile for him to be a landlord. That return is at least in part at the expense of the tenant. In this regard the landlord is akin to the middle-man, the exclusion of which would be of benefit to the prospective freeholder. Without doing any sums or market analysis, therefore, I would expect the outright purchase to be the winning option.

The information about expected returns from the stock market compared to the housing appreciation was taken from Forbes or Fortune. You are correct that these were based on averages.

 

Then again, I tend to be a fairly conservative investor. Most of my funds (say 80%) tend to go into an incredible boring profile.

 

I'm 40 years old. Right now I have about 30% of my funds in bonds. Mostly tax free munis because its looks like a decent time to buy. The remaining 70% are split between various no load index funds. I split this about 66%-33% between domestic funds (S&P 500 and the like) and international indexes.

 

This type of profile requires almost no thought. Everything works almost automatically, and you have an incredibly low expense ratio. Moreover, you don't need to worry about exposure to a small number of stocks (You aren't throwing darts)

 

Admittedly, the remaining 20% is my mad money. This is what I use for silly stuff like going long on urea, copper, oil, and the like. Even though this is "silly money", I don't like to ever take short positions because margin calls are a bitch. I very much prefer going look in an opposite asset (I didn't short the dollar, rather I took a long position in Euros). As I mentioned earlier, right now I'm desperately looking for some way to take a long position on land usage rights for solar energy in either Mexico or Morrocco.

 

Don't get me wrong... I have nothing against buying real estate. The reason that I studied this all over the last couple monthes was to make an informed decision about whether this might be the right time to buy. From what I can tell, housing prices are still significantly overpriced in comparison with both the rental market and the stock market...

[joshs]

Comment 2:  I just did a fairly serious cost / benefit analysis studying whether or not it makes sense to buy a house or continue to rent an apartment.  Rent turned out to be the overwhelming favorite.

 

Rent now, I'm renting a very nice two bedroom apartment for about 1200 a month.  I have plenty of space in a nice town and I'm walking distance to work and the commuter rail lines.  I always heard that you shouldn't buy unless the home price is roughly 100 times your monthly rent.  I'd have to pay 500K for anything comperable.

 

Maybe rental prices in the Boston market are still artifically low compared to home prices; however, even with all the various savings associated with home ownership its still a lot better to sock away 50 grand a year into mutual funds rather than paying down a mortgage, paying real estate taxes, homeowner's insurance, and either (condo fees or maintenance).  I rather be making interest than paying it to someone else.

 

Yes, houses are nice.  Yes its nice not to worry about capital gains.  Even so, over 25 years the stock market will typically outperform the Real Estate market 4:1.  Moreover, if I do decide that the real estate market has bottomed out, I can always start investing cash into real estate funds...

I have no information from which to dispute what you say, but I find it surprising (I find lots of things surprising, mind), and it is at odds with my understanding of the general perception, although my general perception may be coloured by local property market trends. I expect that you calculated the expected return on the stock market by the rise in the index, akin to sticking a pin on the dartboard as an investment policy. Likewise I expect that you calculated the expected return on real estate by a rise in global property prices over a period. A particular individual who is considering this equation in relation to his personal affairs is unlikely to apply so random a policy to either medium. The attitude of the consumer to risk may also be a factor. Traditionally the equity market is regarded as a higher risk investment medium than the property market. If you limit the population of equity products to those with a comparable degree of risk you may find that the expected return drops to something more closely resembling that of the property market.

 

I look at it in possibly overly simplistic terms: In any financial transaction, cutting out the middle-man is usually the winning option for the purchaser and vendor alike, the only loser being the middle-man excluded from the transaction whose profit foregone can then be shared between the remaining end parties. Taking this analogy to the property market, in order for a tenancy to exist there has to be a landlord. The landlord expects a return on his investment, which will come in part from an expected rise in property prices and in part from rental income. The landlord will have done his own sums to determine that the expected return is sufficient to make it worthwhile for him to be a landlord. That return is at least in part at the expense of the tenant. In this regard the landlord is akin to the middle-man, the exclusion of which would be of benefit to the prospective freeholder. Without doing any sums or market analysis, therefore, I would expect the outright purchase to be the winning option.

Robert Shiller did a study on historical US home price appreciation, and found in constant dollars, over the last 100 years, homes have appreciated in value at 1%/year. The S&P on the other hand has been appreciating at more like 7%/year in constant dollars. Thus homes are not great as a pure investment.

 

(Constant dollars means adjusting for inflation)

 

The nice thing about owning a home is that its an asset that you can

a. use (you get value from living there)

and

b. borrow against

 

Its hard to understate the importance of b. Since its hard to move a home, it provides very good colateral for a loan. I read recently, that 70% of all business are started with a 2nd mortgage against their home. (http://www.amazon.com/Mystery-Capital-Capitalism-Triumphs-Everywhere/dp/B0002X7VWU/ref=pd_sim_b_title_1)

 

P.S. Wow, $1200/month for a 2 bedroom in the boston area!

 

For Comparison here is a sample claculation:

 

If you put 100K down on a 500K property

Your mothnly Mortgage payment (@6%) would be $2400 which works out (initially) as $2000/month in interest and $400/month in principle. there is also tax and insurance which I will estimate at $600/month and maintance of $200/month (I am probably underestimating this).

 

the principle amount you are basically paying to yourself, and you get about 1/3 of the interest, tax and insurance back as a tax break, so your net monthly costs are:

2/3*$2600+$200=$2000

 

Now if you rent, you didn't have to make the $100K down payment. Assuming that you make 6% a year on this money, you are earning $500/month. So your rental net is $1200-$500=$700

 

So in this scenario, buying requires almost 3 times the monthly spending, even after taking into account the tax credits.

In order to make up for the $1300/month the home needs to appreciate at a rate of 12*1300/500000=3.1%/year just to break even. (Actually its a bit more than this, since the principle portion could have been invested at a higher yield rather than going into the house, but thats a second order effect).

 

Over time, this required % will go down, since rents will go up, and the % of money you pay as principle also goes up.

[hrothgar]

Comment 2:  I just did a fairly serious cost / benefit analysis studying whether or not it makes sense to buy a house or continue to rent an apartment.  Rent turned out to be the overwhelming favorite.

 

Rent now, I'm renting a very nice two bedroom apartment for about 1200 a month.  I have plenty of space in a nice town and I'm walking distance to work and the commuter rail lines.  I always heard that you shouldn't buy unless the home price is roughly 100 times your monthly rent.  I'd have to pay 500K for anything comperable.

 

Maybe rental prices in the Boston market are still artifically low compared to home prices; however, even with all the various savings associated with home ownership its still a lot better to sock away 50 grand a year into mutual funds rather than paying down a mortgage, paying real estate taxes, homeowner's insurance, and either (condo fees or maintenance).  I rather be making interest than paying it to someone else.

 

Yes, houses are nice.  Yes its nice not to worry about capital gains.  Even so, over 25 years the stock market will typically outperform the Real Estate market 4:1.   Moreover, if I do decide that the real estate market has bottomed out, I can always start investing cash into real estate funds...

I have no information from which to dispute what you say, but I find it surprising (I find lots of things surprising, mind), and it is at odds with my understanding of the general perception, although my general perception may be coloured by local property market trends. I expect that you calculated the expected return on the stock market by the rise in the index, akin to sticking a pin on the dartboard as an investment policy. Likewise I expect that you calculated the expected return on real estate by a rise in global property prices over a period. A particular individual who is considering this equation in relation to his personal affairs is unlikely to apply so random a policy to either medium. The attitude of the consumer to risk may also be a factor. Traditionally the equity market is regarded as a higher risk investment medium than the property market. If you limit the population of equity products to those with a comparable degree of risk you may find that the expected return drops to something more closely resembling that of the property market.

 

I look at it in possibly overly simplistic terms: In any financial transaction, cutting out the middle-man is usually the winning option for the purchaser and vendor alike, the only loser being the middle-man excluded from the transaction whose profit foregone can then be shared between the remaining end parties. Taking this analogy to the property market, in order for a tenancy to exist there has to be a landlord. The landlord expects a return on his investment, which will come in part from an expected rise in property prices and in part from rental income. The landlord will have done his own sums to determine that the expected return is sufficient to make it worthwhile for him to be a landlord. That return is at least in part at the expense of the tenant. In this regard the landlord is akin to the middle-man, the exclusion of which would be of benefit to the prospective freeholder. Without doing any sums or market analysis, therefore, I would expect the outright purchase to be the winning option.

Robert Shiller did a study on historical US home price appreciation, and found in constant dollars, over the last 100 years, homes have appreciated in value at 1%/year. The S&P on the other hand has been appreciating at more like 7%/year in constant dollars. Thus homes are not great as a pure investment.

 

(Constant dollars means adjusting for inflation)

 

The nice thing about owning a home is that its an asset that you can

a. use (you get value from living there)

and

b. borrow against

 

Its hard to understate the importance of b. Since its hard to move a home, it provides very good colateral for a loan. I read recently, that 70% of all business are started with a 2nd mortgage against their home. (http://www.amazon.com/Mystery-Capital-Capitalism-Triumphs-Everywhere/dp/B0002X7VWU/ref=pd_sim_b_title_1)

 

P.S. Wow, $1200/month for a 2 bedroom in the boston area!

 

For Comparison here is a sample claculation:

 

If you put 100K down on a 500K property

Your mothnly Mortgage payment (@6%) would be $2400 which works out (initially) as $2000/month in interest and $400/month in principle. there is also tax and insurance which I will estimate at $600/month and maintance of $200/month (I am probably underestimating this).

 

the principle amount you are basically paying to yourself, and you get about 1/3 of the interest, tax and insurance back as a tax break, so your net monthly costs are:

2/3*$2600+$200=$2000

 

Now if you rent, you didn't have to make the $100K down payment. Assuming that you make 6% a year on this money, you are earning $500/month. So your rental net is $1200-$500=$700

 

So in this scenario, buying requires almost 3 times the monthly spending, even after taking into account the tax credits.

In order to make up for the $1300/month the home needs to appreciate at a rate of 12*1300/500000=3.1%/year just to break even. (Actually its a bit more than this, since the principle portion could have been invested at a higher yield rather than going into the house, but thats a second order effect).

 

Over time, this required % will go down, since rents will go up, and the % of money you pay as principle also goes up.

Hi Josh

 

Few quick comments:

 

1. Your numbers are in the right ballpark. You estimation of taxes and insuance seems a bit high and maintance seems a bit low, but this all washes out.

 

2. You neglected to note that Massachusetts lets you deduct apartment rent from state income taxes

 

3. On the rent front: I'm living in Natick, which is a bit far from Boston proper. Somerville, Cambridge, even Watertown and the like are a lot more expensive.

 

Still, its only a 40 minute drive to the harbour and an hour by commuter rail.... More important, I can walk to work in 20 minutes :-)

[mike777]

Bottom line if you do not want the risk of ownership you need to transfer that risk or the PV of the house to someone else...you can right now.

Yes but people tend to live in the house they own, for obvious reasons. They want to be able to make modifications to the house they live in without having to ask a landlord. They want to the increase in value of the house, which comes from their good care for their house, to go to themselves, not to the landlord. They don't want to pay for the overhead associated with renting.

 

I propose a mechanism that would allow homeowners to keep those advantages without being forced to face the risk associated with fluctuations in the overall house prices.

Helene:

 

If I understand your basic theory, you want something that keeps the upside of the house gains but something that has no downside risk.

 

Keep in mind houses go up or down in value for many many reasons not just because what the Nat home market does. I think it would be impossible for an instrument to protect you from all downside risk and still allow for a few upside risks. B) In real estate I would estimate 90-99% of the reasons for the price of your home to go up or down are local reasons, very local reasons, not worldwide overall housing prices.

 

Here is just one local example. Four houses out of 12 on my tiny block have been sold or are up for sale the last 12 months. All the prices are up in the middle of a worldwide housing crises. :)

 

Perhaps without the crises they would be even higher, who knows.

[mike777]

Bottom line if you do not want the risk of ownership you need to transfer that risk or the PV of the house to someone else...you can right now.

Yes but people tend to live in the house they own, for obvious reasons. They want to be able to make modifications to the house they live in without having to ask a landlord. They want to the increase in value of the house, which comes from their good care for their house, to go to themselves, not to the landlord. They don't want to pay for the overhead associated with renting.

 

I propose a mechanism that would allow homeowners to keep those advantages without being forced to face the risk associated with fluctuations in the overall house prices.

Let me please try some finance jargon. :)

Systemic risk

Nonsystemic risk

 

For simplicity I am going to ignore fat tails, or that in a worldwide nuclear war correlations go to one. B)

 

In Real estate let's call Nonsystemic risk, local real estate risk in your home. Let's also assume nonsystemic risk is 95% of all total risk.

 

Let's call systemic risk, nat and worldwide realestate risk. Assume 5% of all risk.

 

The neat thing in finance is we can diversify away, nonsystemic risk. We can kill it. :) We may or may not want to but we have the ability to do so. In fact we can twist it, transport it and do all kinds of neat tricks with it. The same with the profit, we can kill it, transport it, twist it and do all kinds of neat tricks with it.

 

That just leaves 5% systemic risk in our assumption. Of course we get all our profit or loss now from only systemic risk. Almost all home owners would not want to do this. They much prefer to live with the local risk, which is why in real estate they say there are only three important things in real estate. :)

 

1) location

2) location

3) and location

 

:)

[hrothgar]

That just leaves 5% systemic risk. Of course we get all our profit or loss now from only systemic risk. Almost all home owners would not want to do this. They much prefer to live with the local risk,

The existence of

 

homeowner's insurance

fire insurance

flood insurance

 

and the like would seem to contradict your statement

[helene_t]

If I understand your basic theory, you want something that keeps the upside of the house gains but something that has no downside risk.

That's not what I had in mind but it's a detail. Maybe some homeowners would like to buy off all risk associated with the general house market while others would like to buy off only the risk of a loss. If that's a big issue (I suspect it is not but what do I know) two parallel instruments could be created. I was using the word "futures" which implies that both positive and negative risk would be bought off. If I had thought off negative risk only I would have used the word "options" (or "warrants").

 

I think it's quite simple. Contractors buy off market risks associated with fluctuations in raw material markets. That's standard. I just want homeowners to have a similar posibility.

 

Obviously I am wording this very badly since you can't understand it.

 

I don't understand your distinction between systemic and nonsystemic risk. If my local market risk is 95% associated with things specific to Lancashire and only 5% with the general UK trend in house prices, obviously I would need a (negative) future on the Lancashire market. If you mean 95% associated with my specific house (like the risk that nobody wants to buy my house because the neighbors have a pitbull terrier) then obviously my suggestion would not work, but then again this whole thread would be somewhat irrelevant.