Rejoice! Your House Is An Investment Again

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Re: Rejoice! Your House Is An Investment Again

Postby Valuethinker » Tue May 07, 2013 8:24 am

steadyeddy wrote:
Scooter57 wrote:Baloney!

Your house price is rising only because people are being offered ridiculously low mortgage rates. When rates rise--as they are certain to do within the next decade, it will take more income to afford the same priced home and your home's value will drop to where people in your region can afford itl


Interest rates do play a role in affordability, but they are only one slice of the pie. If interest rates rise while unemployment falls, will housing prices go up or down? In my own area, vacancy is below 3% and rents are increasing dramatically faster than income. At least in the short run, people will not move out of town or become homeless--they will simply allow housing to take a larger share of their income. Healthcare and education are examples of other sectors that have seen prices outpace wage growth recently with little effect on demand.


If you wiki 'Baumol's Cost Disease' you'll get a good explanation of what happens in higher ed and healthcare.

Housing it is the lack of substitution. If your good paying tech job is in Silicon Valley, cheap good housing in Texas is irrelevant to you. If you work in tech or the securities industry, then you work in the Bay Area or in New York (or Boston or Chicago to a much lesser extent). Probably more than half the tech company jobs in USA are in the Bay Area.

So you are right. If people have jobs and incomes rising, then they will push affordability to the limit to live in a good area, with good schools, relatively close to work. That's why per square foot on the Upper West Side of NYC you probably pay over $2000. Central London you can pay USD 5000.

Interest rates has an impact, but it's not the only factor.
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Re: Rejoice! Your House Is An Investment Again

Postby Scooter57 » Tue May 07, 2013 9:43 am

If housing gets too expensive, people won't pony up more money, because they won't have it. They'll rent, which is what always happens with Real Estate. And the rents won't be enough to cover the costs of purchasing overpriced upscale housing, which is why the dream of getting rich flipping expensive houses only works when there are more flippers to sell to. You can't rent a lot of houses for more than what people making the typical wage in the region can afford. NYC and Silicon Valley are outliers. The median family income in the US is still somewhere around $50K. They call the 1% "the one percent" for a reason, and you are not going to get rich flipping houses that only 1% of people could afford to buy or rent. Flipping houses didn't work out so well in the 2000s, and I don't see any changes in the economy that make it any more likely to succeed now.

There's another factor that doesn't get discussed enough: People in their mid-20s to 30s with excellent jobs are carrying a much higher load of student debt (we saw the doctors discussing this in another thread here.) So they are not going to be able to pay monthly payments that represent a percentage of income comparable to those that an earlier generation bought at the same stage of their careers.

So it's very likely that the supposedly reawakening RE market is flippers buying from retirees and banks and trading with other flippers, which works until it stops working. What we aren't seeing the huge influx of first home buyers in their 20s and early 30s who are forming families and putting down roots that is what it take to get a real bull market in RE started. Real estate booms are sustained only when a lot of people in that household formation phase have good jobs and stable earnings. Until that happens, I'd be very cautious about buying real estate for any reason except that you find a house you want to live in (and pay for!) for many more years to come.
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Re: Rejoice! Your House Is An Investment Again

Postby ourbrooks » Tue May 07, 2013 10:05 am

Valuethinker wrote:
Housing it is the lack of substitution. If your good paying tech job is in Silicon Valley, cheap good housing in Texas is irrelevant to you. If you work in tech or the securities industry, then you work in the Bay Area or in New York (or Boston or Chicago to a much lesser extent). Probably more than half the tech company jobs in USA are in the Bay Area.

So you are right. If people have jobs and incomes rising, then they will push affordability to the limit to live in a good area, with good schools, relatively close to work. That's why per square foot on the Upper West Side of NYC you probably pay over $2000. Central London you can pay USD 5000.


Even the lack of substitution has its limits. Silicon Valley firms are finding it increasingly difficult to recruit new graduates because of the near impossibility of ever owning a home; that's why many of them are opening engineering centers in Texas, which has less expensive housing. I also note that Texas is to the oil/gas business what Silicon Valley is to the electronics/software businesses and, recently, the oil/gas business has been growing faster. Possibly due to either geography more conducive to housing expansion and/or a state regulatory climate which discourages uncontrolled lending practices and/or lower wages, Texas has not seen quite the housing bubble of other areas of the country.

In any case, the rise in prices for a few areas in which the amount of housing stock is limited is not characteristic of the country as a whole. Instead of Silicon Valley, think Chicago/Cleveland/Detroit/Minneapolis/Charlotte/Dallas.
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Re: Rejoice! Your House Is An Investment Again

Postby Dulocracy » Tue May 07, 2013 11:43 am

The sad part of this thread is that no one seems to have read or be commenting on the related article. The point of the article is that, in general, housing is back on track. The point of the article is not that your value in your area will be back to the inflated numbers we saw before, but that the value of the house should increase with inflation. Your house was way overvalued? You bought at a great rate? At this point, think of your house as an I-Bond - it will behave as it should. Think that is a gross oversimplification? Well, it is. Want a better portrayal? Read the article. THEN comment on the article.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.
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Re: Rejoice! Your House Is An Investment Again

Postby swaption » Tue May 07, 2013 11:51 am

The extent of debate on this topic is insane. Let's say today you have $X. One can take $X and borrow $4X and buy a house or choose to rent. 30 years from now, the preson decides to retire. The own/rent decision will have some impact on terminal wealth, not unlike a decision to invest in stock or bonds. There will be some volatility in terms of the outcome. There can be some expectation regarding expected returns. Market forces govern prices relative to alternatives. You know the saying, if it looks like a duck, and sounds like a duck... By any measure, a house is an investment. It is really very simple.

Now in terms of the question of whether it is a good investment? Tax policy is on your side. There should be a risk and liquidity premium. But even 1% real on a levered basis is not a bad return on your $X (before taking into account and imputed rent/cost of ownership arbitrage). And yes, appreciation should be higher in high density areas where scarcity is on your side, but then again prices should adjust for that.
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Re: Rejoice! Your House Is An Investment Again

Postby YDNAL » Tue May 07, 2013 12:42 pm

Rick Ferri wrote:The bubble has popped and home prices are back down to their inflation-adjusted values. A home may not make a great investment, but you have to live someplace, and it beats paying rent. For a long-term perspective...

Buzz words are sometimes used to solicit reaction.... something like "great investment" could be seen in this regard. Besides, I wouldn't be too quick to surmise that "it beats paying rent."

To put a roof over my head, I would look at 3 potential options:
    1. Pay Rent to a landlord.
    2. Pay in full and consider reasonable lost opportunity of capital in addition to ongoing expenses (tax, insurance, upkeep, etc).
    3. Pay X% down payment and use leverage - while knowingly adding to expenses above (interest).
ALL else just creates debate, IMHO, which I find a waste of time.

ps. Item #2 is no different than some long-term homeowner with no leverage.
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Re: Rejoice! Your House Is An Investment Again

Postby MindBogler » Tue May 07, 2013 1:01 pm

Unless you're living in a box under an overpass, you are paying to live somewhere every month. You can choose to pay yourself, in the form of compounding principle increases, or to pay someone else the same. With interest rates at historic lows and prices also in the toilet most people are only shorting themselves by thinking it is cheaper to rent. That may be the case in some extreme outlier situations but, on average, owning is a steal right now. There is an awful lot of discussion about hidden costs of ownership, but that is all just a red herring. What about the hidden cost of renting, which is to say, the cost of dumping money down the drain and getting absolutely nothing real in return? :oops:
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Re: Rejoice! Your House Is An Investment Again

Postby YDNAL » Tue May 07, 2013 1:21 pm

MindBogler wrote:Unless you're living in a box under an overpass, you are paying to live somewhere every month.
Yes

You can choose to pay yourself, in the form of compounding principle increases, or to pay someone else the same.
That is known as "savings" when you pay rent

With interest rates at historic lows and prices also in the toilet most people are only shorting themselves by thinking it is cheaper to rent. That may be the case in some extreme outlier situations but, on average, owning is a steal right now.
Assumption on your part

MindBogler wrote:There is an awful lot of discussion about hidden costs of ownership, but that is all just a red herring. What about the hidden cost of renting, which is to say, the cost of dumping money down the drain and getting absolutely nothing real in return? :oops:

You have it almost backwards!

When you own a piece of real estate, you are dumping money down the drain in the form of tax, insurance, HOA (if any), regular upkeep, maintenance, etc.; then add to that interest (if leveraged) that your financial institution is happy to take, and the lost opportunity of capital invested in this real estate. If ALL OF THIS is lower than Rent, then only the difference would be pissed away. The opposite may apply.

disclosure: I'm a multiple homeowner and professional real estate investor.
Last edited by YDNAL on Tue May 07, 2013 1:22 pm, edited 1 time in total.
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Re: Rejoice! Your House Is An Investment Again

Postby Honobob » Tue May 07, 2013 1:22 pm

Dulocracy wrote: The point of the article is that, in general, housing is back on track. The point of the article is not that your value in your area will be back to the inflated numbers we saw before, but that the value of the house should increase with inflation. Your house was way overvalued? You bought at a great rate? At this point, think of your house as an I-Bond - it will behave as it should. Think that is a gross oversimplification? Well, it is. Want a better portrayal? Read the article. THEN comment on the article.

Hey, I read the article and strongly disagree that real estate SHOULD appreciate at the rate of inflation. But it is back on track.
Check this out.
http://www.realtor.com/realestateandhom ... 8034?row=5
Purchased in May 2009 for $1,227,000. Probably will be overbid so the owner is looking at annual 16%+ compounded appreciation!!
That's how you invest in real estate!
Last edited by Honobob on Tue May 07, 2013 2:34 pm, edited 1 time in total.
It's slowly dawned on me that we won the real estate lottery!
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Re: Rejoice! Your House Is An Investment Again

Postby MindBogler » Tue May 07, 2013 1:41 pm

YDNAL wrote:You have it almost backwards!

When you own a piece of real estate, you are dumping money down the drain in the form of tax, insurance, HOA (if any), regular upkeep, maintenance, etc.; then add to that interest (if leveraged) that your financial institution is happy to take, and the lost opportunity of capital invested in this real estate. If ALL OF THIS is lower than Rent, then only the difference would be pissed away. The opposite may apply.

disclosure: I'm a multiple homeowner and professional real estate investor.

Someone is always paying those things, there is no free lunch. I can't help but laugh, though. You call me backwards, but then disclaim owning multiple homes and professionally investing in real estate. You must absolutely love dumping money down the drain compared to those renters! :confused
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Re: Rejoice! Your House Is An Investment Again

Postby YDNAL » Tue May 07, 2013 5:50 pm

MindBogler wrote:There is an awful lot of discussion about hidden costs of ownership, but that is all just a red herring. What about the hidden cost of renting, which is to say, the cost of dumping money down the drain and getting absolutely nothing real in return? :oops:
MindBogler wrote:
YDNAL wrote:When you own a piece of real estate, you are dumping money down the drain in the form of tax, insurance, HOA (if any), regular upkeep, maintenance, etc.; then add to that interest (if leveraged) that your financial institution is happy to take, and the lost opportunity of capital invested in this real estate. If ALL OF THIS is lower than Rent, then only the difference would be pissed away. The opposite may apply.

Someone is always paying those things, there is no free lunch. I can't help but laugh, though. You call me backwards, but then disclaim owning multiple homes and professionally investing in real estate. You must absolutely love dumping money down the drain compared to those renters! :confused

In blue is part of your first post that you didn't include in your last post. With regards to the last post, MindBogler,
  • What someone ?
  • What free lunch ?
1. As a renter, one chooses to pay a landlord.
2. As a homeowner, one chooses to pay other expenses; but there is nothing "red herring" about interest (leverage), taxes, insurance, etc. etc.
3. Thus, the only thing that should command your attention is the difference between the two.

I hope that helps clear all the question marks in your emoticon. :)
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Re: Rejoice! Your House Is An Investment Again

Postby MindBogler » Tue May 07, 2013 6:08 pm

Indeed, I did miss your remarks, in blue, in the first post. However, I still do not agree.

I guess I have to itemize this:

1. If owning property is such a bad investment, then why do you own property? Hence my confusion as you claim A and do B.
2. The argument that rent > own because of "taxes, insurance, etc. etc." is a red herring. Renters implicitly pay all those things (and owners get to write them off). Landlords get to take your principle and the tax write-offs.
3. The difference between the two does matter and my premise is that the difference is miniscule or non-existent at this time in numerous local markets.

Is owning always better than renting? Obviously no, but neither is renting always greater than owning, as you seem to imply.
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Re: Rejoice! Your House Is An Investment Again

Postby YDNAL » Tue May 07, 2013 7:52 pm

MindBogler wrote:Indeed, I did miss your remarks, in blue, in the first post. However, I still do not agree.

I guess I have to itemize this:

1. If owning property is such a bad investment, then why do you own property? Hence my confusion as you claim A and do B.
2. The argument that rent > own because of "taxes, insurance, etc. etc." is a red herring. Renters implicitly pay all those things (and owners get to write them off). Landlords get to take your principle and the tax write-offs.
3. The difference between the two does matter and my premise is that the difference is miniscule or non-existent at this time in numerous local markets.

Is owning always better than renting? Obviously no, but neither is renting always greater than owning, as you seem to imply.

Your posts are confusing. We shall back-up some to summarize facts.
    Fact 1 - I do not take sides in these discussion - and haven't here.
    Fact 2 - YOU posted about home ownership costs as "red herrings." These costs are neither misleading nor distracting.
    Fact 3 - unless one doesn't place value on a roof over your head, its cost - whether Rent or Ownership - should not be considered "dumping money down the drain" - as YOU said.
    Fact 4 - one either rents or owns (living under a bridge not being an option).
    Fact 5 - one option or the other may be favorable (financially) - what matters is the difference.
    Faxt 6 - If a Rent/ownership difference were to be "miniscule" - despite the fact this is conjecture and unfounded as a general statement - then these decisions could be relegated to other non-financial considerations.
I trust that puts an end to this run-around exchange.
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Re: Rejoice! Your House Is An Investment Again

Postby Rick Ferri » Tue May 07, 2013 8:00 pm

I've learned over the past few weeks that there are two investment topics that people become very passionate about - gold and houses.

Rick Ferri
Mutual fund investing is simple. There is risk, there is return, and there are costs. All else is marketing.
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Re: Rejoice! Your House Is An Investment Again

Postby swaption » Wed May 08, 2013 11:28 am

YDNAL wrote:
Faxt 6 - If a Rent/ownership difference were to be "miniscule" - despite the fact this is conjecture and unfounded as a general statement - then these decisions could be relegated to other non-financial considerations.[/list]I trust that puts an end to this run-around exchange.


At the risk of beating a dead horse, I do have one further comment. Obviously, most of what you wrote can't really be open to debate, with the possible exception of this last fact. Ultimately, the risk and liquidity profile of owning versus renting is different, which may be particularly true of one follows the typical path of owning with a mortgage. Intuitively this translates to the benefits that renters realize in the form of added flexibility. For instance, among the primary considerations people have when deciding to purchase a home is the stability of income, and this is basically the manifestation of the additional risk and illiquidity. What this means is that there should be some expected premium to owning if viewed on an apples to apples basis adjust for the risk factors, and this premium can represent a reasonable expectation of the return for a long term owner. What it also means, is if the difference is "miniscule", then an edge to renting is implied, putting aside non-financial considerations. I don't consider risk and illiquidity a non-financial consideration.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Wed May 08, 2013 11:41 am

swaption wrote: For instance, among the primary considerations people have when deciding to purchase a home is the stability of income, and this is basically the manifestation of the additional risk and illiquidity. What this means is that there should be some expected premium to owning if viewed on an apples to apples basis adjust for the risk factors, and this premium can represent a reasonable expectation of the return for a long term owner.

Not necessarily - not all risks one can take are going to be compensated for with expected returns. Particularly if those risks can be diversified away by those not buying a single individual home or are reliant on a single cash flow source tied to a specific location today that may change tomorrow.
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Re: Rejoice! Your House Is An Investment Again

Postby swaption » Wed May 08, 2013 12:44 pm

avalpert wrote:
swaption wrote: For instance, among the primary considerations people have when deciding to purchase a home is the stability of income, and this is basically the manifestation of the additional risk and illiquidity. What this means is that there should be some expected premium to owning if viewed on an apples to apples basis adjust for the risk factors, and this premium can represent a reasonable expectation of the return for a long term owner.

Not necessarily - not all risks one can take are going to be compensated for with expected returns. Particularly if those risks can be diversified away by those not buying a single individual home or are reliant on a single cash flow source tied to a specific location today that may change tomorrow.


You know, at first I scratched my head at this comment, but I actually think it is very thought provoking. Much like stocks, prices (and expected returns) can be expected to be based on a diversified portfolio. The analogy here that comes mind would be large apartment owners that can be expected to drive the purchase price for apartments. Much like the buyer of a single stock, a buyer of a single apartment should theoretically be expected to pay a price that would provide a return commensurate with a diversified holder, essentially taking uncompensated risk. Interesting thought. Perhaps a slightly different analysis with single family homes.
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Re: Rejoice! Your House Is An Investment Again

Postby 2wolves » Wed May 08, 2013 3:29 pm

Rick Ferri wrote:I've learned over the past few weeks that there are two investment topics that people become very passionate about - gold and houses.

Rick Ferri


I must admit that my first instinct was to find something to critique based on the title of the thread. But then I read the blog and it was mostly benign. I'm kind of surprised at the lengths some people will stretch their arguments just so they have something to argue about.
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Re: Rejoice! Your House Is An Investment Again

Postby MindBogler » Wed May 08, 2013 4:06 pm

YDNAL wrote:
    Fact 1 - I do not take sides in these discussion - and haven't here.
    You have most certainly taken a side. I'm flexible because I believe that housing is a good buy right now. I've stated no other position.
    Fact 2 - YOU posted about home ownership costs as "red herrings." These costs are neither misleading nor distracting.
    They are distracting because rent implicitly includes these costs.
    Fact 3 - unless one doesn't place value on a roof over your head, its cost - whether Rent or Ownership - should not be considered "dumping money down the drain" - as YOU said.
    Giving a sum of money to someone else which could be given to yourself is my idea of dumping down the drain.
    Fact 4 - one either rents or owns (living under a bridge not being an option).
    I suppose one could live with their parents...
    Fact 5 - one option or the other may be favorable (financially) - what matters is the difference.
    Yes, we agree. Except I don't think the difference is all that great at this time. You say that is conjecture and then claim the opposite. I suppose we're both full of conjecture.
    Faxt 6 - If a Rent/ownership difference were to be "miniscule" - despite the fact this is conjecture and unfounded as a general statement - then these decisions could be relegated to other non-financial considerations.
I trust that puts an end to this run-around exchange.

See above.
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Re: Rejoice! Your House Is An Investment Again

Postby umfundi » Wed May 08, 2013 11:08 pm

2wolves wrote:
Rick Ferri wrote:I've learned over the past few weeks that there are two investment topics that people become very passionate about - gold and houses.

Rick Ferri


I must admit that my first instinct was to find something to critique based on the title of the thread. But then I read the blog and it was mostly benign. I'm kind of surprised at the lengths some people will stretch their arguments just so they have something to argue about.

The problem is the title of the thread.

Your House Is An Investment Again

Really? Your house used to be an investment, then it was not, now it is again.

How does that signal work?

For many reasons, most people should not regard the primary residence that they own as an investment.

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Re: Rejoice! Your House Is An Investment Again

Postby madbrain » Thu May 09, 2013 12:12 am

Tortoise wrote:I apparently live in one of those non-average regions. Average home prices are shooting up again here in West San Jose, California. They are higher than ever. :shock:


Well, just come to East San Jose then. The prices are not anywhere near their peaks.

Image

Note - this is my neighbor's home, just accross from mine - because Zillow somehow can't figure out any value for mine prior to 2009 .
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Re: Rejoice! Your House Is An Investment Again

Postby madbrain » Thu May 09, 2013 12:17 am

Rick Ferri wrote:I've learned over the past few weeks that there are two investment topics that people become very passionate about - gold and houses.



Only two ?

Seems high-yield bonds and the Small value premium are at least as good a source of passion on the BH forum .
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Re: Rejoice! Your House Is An Investment Again

Postby sashwin » Thu May 09, 2013 3:17 am

Rick Ferri wrote:I've learned over the past few weeks that there are two investment topics that people become very passionate about - gold and houses.

Rick Ferri


Maybe you recently discovered the passion around houses, but on gold the PP folks have been beating you up for years :D

--Ashwin
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Re: Rejoice! Your House Is An Investment Again

Postby nonnie » Thu May 09, 2013 8:38 pm

Leif Eriksen wrote:
Tortoise wrote:I apparently live in one of those non-average regions. Average home prices are shooting up again here in West San Jose, California. They are higher than ever. :shock:


That's right. Silicon Valley is not average. :wink:


I seem to recall a heated discussion here close to a year ago on whether prices in CA would ever go up again! We're not in Silicon Valley nor in Napa or Sonoma which are also hot but overall CA prices are up 17.4% over a year ago. We're in a nice little town in Northern CA where a house down the block from me-- improvements not quite as nice, yard not nearly as nice and plus our lot is 30% larger and backs up to open space--sold last month for $100K more than we paid a year ago. March 2012 was the very bottom of the market here. Now if this can just hold steady for 9 more years until we're ready to sell...
This post may be monitored for quality assurance purposes.
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Re: Rejoice! Your House Is An Investment Again

Postby Rolyatroba » Thu May 09, 2013 10:41 pm

I am new here, but quite surprised that net present value has not entered this discussion.

Net Present Value (NPV) is the only way to approach this topic. When faced with a buy vs. rent decision (which should be part of all retirement planning), if you don't use NPV analysis (with reasonable inputs), you're making a mistake.

With NPV, this topic becomes trivial. Someone thinking of purchasing a home should estimate the future cash flows (including tax-related flows), and compare that with the NPV analysis of the cash flows related to renting. The alternative with the higher NPV wins. Retirees should consider similarly the cash flows of keeping their home and retiring there, versus selling and renting/buying elsewhere. Etc., etc.

Some of the inputs to the NPV analysis, particularly rates of appreciation, can be difficult to forecast, but that can be a variable input that you slide to see the different outcomes.

Please don't debate the validity of this particular premise--your house may or may not be an investment again; it depends on where you live, what your means are, and what you want to do. Analyze the alternatives with objective (mostly) information and you'll make the right choice.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Thu May 09, 2013 11:02 pm

Rolyatroba wrote:I am new here, but quite surprised that net present value has not entered this discussion.

Net Present Value (NPV) is the only way to approach this topic. When faced with a buy vs. rent decision (which should be part of all retirement planning), if you don't use NPV analysis (with reasonable inputs), you're making a mistake.

With NPV, this topic becomes trivial. Someone thinking of purchasing a home should estimate the future cash flows (including tax-related flows), and compare that with the NPV analysis of the cash flows related to renting. The alternative with the higher NPV wins. Retirees should consider similarly the cash flows of keeping their home and retiring there, versus selling and renting/buying elsewhere. Etc., etc.

Some of the inputs to the NPV analysis, particularly rates of appreciation, can be difficult to forecast, but that can be a variable input that you slide to see the different outcomes.

Please don't debate the validity of this particular premise--your house may or may not be an investment again; it depends on where you live, what your means are, and what you want to do. Analyze the alternatives with objective (mostly) information and you'll make the right choice.


NPV on its own is inadequate, it ignores opportunity costs, it doesn't really account for risks (such as the need to liquidate the cash in the house for whatever reason) and of course the results are highly sensitive to the assumed discount rate.

At the end of the day, it is as likely (if not more likely) to lead to undue confidence in a decision based on false precision than an objective analysis.
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Re: Rejoice! Your House Is An Investment Again

Postby Rolyatroba » Thu May 09, 2013 11:33 pm

Ok...first, the discount rate is something I'd expect Bogleheads to to predict fairly well--it should be the rate of return you expect for using the discretionary funds elsewhere; and the discount rate is also something you can set as a variable--easy to see how that changes the outcomes.

And as for unforeseeable risks, do you have a better model for accounting for that? What do you see as an alternative to NPV to make an analysis that includes such risks?

Finally, for opportunity costs, if it is something that can be quantified, the NPV analysis can easily include that input. What opportunity costs can you imagine that might not be possible for inclusion in an NPV analysis?
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Fri May 10, 2013 12:00 am

Rolyatroba wrote:Ok...first, the discount rate is something I'd expect Bogleheads to to predict fairly well--it should be the rate of return you expect for using the discretionary funds elsewhere; and the discount rate is also something you can set as a variable--easy to see how that changes the outcomes.

Why would Bogleheads be any better to predict the risk free rate of return over several decades better than anyone else?

And as for unforeseeable risks, do you have a better model for accounting for that? What do you see as an alternative to NPV to make an analysis that includes such risks?

One that actually accounts for them. If you want to do it and still get the beauty of false precision to pretend like your decision is truly objective you can use monte carlo simulations.

Finally, for opportunity costs, if it is something that can be quantified, the NPV analysis can easily include that input. What opportunity costs can you imagine that might not be possible for inclusion in an NPV analysis?

NPV by definition does not take into account opportunity costs. Perhaps you mean to say you could do NPV analysis on other opportunities and compare the NPV to choose the best one. Of course when those other opportunities (like say investing the capital in the stock market) also have highly volatile outcomes we come back to accounting for the risk of different outcomes that is lost when reducing it to a single number for comparison.
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Re: Rejoice! Your House Is An Investment Again

Postby Valuethinker » Fri May 10, 2013 3:54 am

Rick Ferri wrote:I've learned over the past few weeks that there are two investment topics that people become very passionate about - gold and houses.

Rick Ferri


It does not help that you have not understood, or at least not communicated, the economic concept of housing.

Housing pays an imputed rental value to its occupants-- you can't live in your stock portfolio but you can live in a property you own. That's why housing has lower long run expected returns than other financial assets.

The other peculiarity of housing is you can buy it on margin-- up to 80% margin (up to 100% before the Crash). And you are not 'marked to market' on your Loan-to-Value-- it's long term finance, you cannot get margin called.

These factors, plus lags in supply and demand, contribute to the boom bust nature of housing cycles. You have got a fundamental reason for pricing cycles (supply and demand lags) and a financial reason (leverage and the possibility of speculative leverage).

The point about housing is:

- it has a utility value of living in it
- it has (probably) greater correlation with inflation than stocks. However it's easy to get confused between the long term inflation hedge of a fixed interest rate long term debt (the mortgage) and your housing equity (the latter is your 'investment' in equity)
- it's completely non diversified, which is great if you bought in Manhattan in 1976 when the City teetered on the edge of bankruptcy, and not so great if you bought in a Bubble State (CA, NV, OH, FLA, CO, AZ were, I think, the worst hit, or at least the ones with the most egregious lending practices) in 2007

You can 'call' housing cycles: Calculated Risk has done so brilliantly, which is why I posted his 'turn' call in March 2012, and he has been proved even more right than most of us would have expected. But he also called the downturn right. That makes housing somewhat different from stock markets, for example. Again, it has to do with the link between the real economy and lags in supply & demand in housing.

From an investor perspective, it's best to treat your own house as consumption, as a place to live, rather than as an investment. Given long run returns, adjusted for quality improvements, are less than 1% real pa, if you get your money back in real terms at the end of your time as a homeowner (including repair, maintenance, taxes) you've done pretty well.

Neil Monnery 'Safe as Houses' takes you through the multi country data (data series back to Paris about 1300, Holland 1630s etc.).

Robert Shiller takes you through the US data. Irrational Exuberance (2nd edition) plus his website.

Edward Gleaser explains why some housing markets have done so much better than US average. What Paul Krugman dubs 'Flatland' (think Texas) v. 'Zoneland' (think San Francisco and New York City). You need a combination of a strong local industry or industries (security, tech, Hollywood etc.) causing large influxes and high wages *plus* severe constraints on new housing supply.
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Re: Rejoice! Your House Is An Investment Again

Postby Beagler » Fri May 10, 2013 4:27 am

“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.
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Re: Rejoice! Your House Is An Investment Again

Postby Valuethinker » Fri May 10, 2013 7:17 am

avalpert wrote:NPV by definition does not take into account opportunity costs..


Correction. NPV by definition includes the opportunity cost of capital.

That is done via the discount rate. The discount rate (weighted average cost of capital) takes into account the risk adjusted (after tax) rates of return available from other opportunities.

In its simplest form CAPM says that instead of investing in this equity with this beta, you could invest in a portfolio of the risk free asset plus the market portfolio, with that Beta and that expected return).
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Fri May 10, 2013 8:58 am

Valuethinker wrote:
avalpert wrote:NPV by definition does not take into account opportunity costs..


Correction. NPV by definition includes the opportunity cost of capital.

That is done via the discount rate. The discount rate (weighted average cost of capital) takes into account the risk adjusted (after tax) rates of return available from other opportunities.

In its simplest form CAPM says that instead of investing in this equity with this beta, you could invest in a portfolio of the risk free asset plus the market portfolio, with that Beta and that expected return).


WACC only captures the expected minimum return of capital expected of stakeholders (not sure what a WACC would be for an individual buying a home) it does not however compare it to other potential investments on the table. To do that you need to compare NPVs across potential capital investments. In a simple example, what if your choice is between buying a home with your free capital or renting and putting the money into your friends new commercial real estate fund - NPV for the housing decision alone does not compare those opportunities or tell you which option is optimal.
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Re: Rejoice! Your House Is An Investment Again

Postby Rolyatroba » Fri May 10, 2013 10:31 am

avalpert wrote:WACC only captures the expected minimum return of capital expected of stakeholders (not sure what a WACC would be for an individual buying a home) it does not however compare it to other potential investments on the table. To do that you need to compare NPVs across potential capital investments. In a simple example, what if your choice is between buying a home with your free capital or renting and putting the money into your friends new commercial real estate fund - NPV for the housing decision alone does not compare those opportunities or tell you which option is optimal.


You're not understanding NPV if you think you need to figure out what the WACC would be for buying a home. The discount rate (often WACC for businesses facing investment choices, and expected ROI of a nest egg for individuals) applies equally to all cash flows related to the decision. In the rent vs. buy decision for example, all cash flows are discounted back to the present using the expected ROI of one's retirement portfolio, essentially telling you what would happen to those funds had they instead been invested in that portfolio.

Anyone making financial decisions really should look into learning how NPV works. A quick and easy way to see its power is to use it the next time you refi your mortgage, comparing lower-rate loans with points to higher-rate loans without points (every time I've done this the loan with points has won, yet many people don't like points).
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Re: Rejoice! Your House Is An Investment Again

Postby swaption » Fri May 10, 2013 10:42 am

avalpert wrote:
Valuethinker wrote:
avalpert wrote:NPV by definition does not take into account opportunity costs..


Correction. NPV by definition includes the opportunity cost of capital.

That is done via the discount rate. The discount rate (weighted average cost of capital) takes into account the risk adjusted (after tax) rates of return available from other opportunities.

In its simplest form CAPM says that instead of investing in this equity with this beta, you could invest in a portfolio of the risk free asset plus the market portfolio, with that Beta and that expected return).


WACC only captures the expected minimum return of capital expected of stakeholders (not sure what a WACC would be for an individual buying a home) it does not however compare it to other potential investments on the table. To do that you need to compare NPVs across potential capital investments. In a simple example, what if your choice is between buying a home with your free capital or renting and putting the money into your friends new commercial real estate fund - NPV for the housing decision alone does not compare those opportunities or tell you which option is optimal.


Wow, this thing sure has legs. But since we are delving into theory, I think for the most part one assumes that most investment in "market" assets have an NPV of roughly zero. Presumably this applies to the commerical real estate fund. In simplistic terms, a hounsing investment should be a go if it is NPV positive. The WACC is a bit tricky because of the subsidized nature of mortgage financing. I'm guessing that 3.5% over 30 years is artificially low. Presumably, one could could determine the house cash flow with imputed rent and the appreciated value in 30 years as the cash flows in and the 20% down payment, mortgage cash flow over 30 years, taxes, insurance, and maintenance as the cash flows out. This should all be discounted back at some WACC that roughly equates to the minimum risk adjusted return required of one's 20% equity investment as this is being run on a levered basis.

For most , the only comparison that is really relevant is to renting. By including imputed rent in the NPV calculation, one is implicitly making this comparison. If the NPV is positive, then owning wins, at least theoretically.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Fri May 10, 2013 10:56 am

Rolyatroba wrote:
avalpert wrote:WACC only captures the expected minimum return of capital expected of stakeholders (not sure what a WACC would be for an individual buying a home) it does not however compare it to other potential investments on the table. To do that you need to compare NPVs across potential capital investments. In a simple example, what if your choice is between buying a home with your free capital or renting and putting the money into your friends new commercial real estate fund - NPV for the housing decision alone does not compare those opportunities or tell you which option is optimal.


You're not understanding NPV if you think you need to figure out what the WACC would be for buying a home. The discount rate (often WACC for businesses facing investment choices, and expected ROI of a nest egg for individuals) applies equally to all cash flows related to the decision. In the rent vs. buy decision for example, all cash flows are discounted back to the present using the expected ROI of one's retirement portfolio, essentially telling you what would happen to those funds had they instead been invested in that portfolio.

Anyone making financial decisions really should look into learning how NPV works. A quick and easy way to see its power is to use it the next time you refi your mortgage, comparing lower-rate loans with points to higher-rate loans without points (every time I've done this the loan with points has won, yet many people don't like points).


And you are not really following the thread or understanding NPV's limitations. I referenced WACC because Valuethinker did - but I'm not sure it is obvious that expected ROI of your nest egg is the right discount rate for an individual to use in NPV calculations. Putting aside again how bad we are at projecting what that ROI will be, there is nothing to suggest that your nest egg and the house have similar risk profiles so why would that be the right discount rate?

Anyone making financial decision should learn about the limitation of NPV, why business don't make decisions using it in isolation (and neither should you), and understand why you should be very wary of reducing financial decisions to a single number when the assumptions that go into deriving that number have large uncertainty bars.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Fri May 10, 2013 10:59 am

swaption wrote:Wow, this thing sure has legs. But since we are delving into theory, I think for the most part one assumes that most investment in "market" assets have an NPV of roughly zero. Presumably this applies to the commerical real estate fund.

Why would you assume that for a commercial real estate investment when you aren't assuming that for a residential real estate investment?
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Re: Rejoice! Your House Is An Investment Again

Postby swaption » Fri May 10, 2013 11:04 am

avalpert wrote:
swaption wrote:Wow, this thing sure has legs. But since we are delving into theory, I think for the most part one assumes that most investment in "market" assets have an NPV of roughly zero. Presumably this applies to the commerical real estate fund.

Why would you assume that for a commercial real estate investment when you aren't assuming that for a residential real estate investment?


I did consider this. I guess I'm more open to the potential of some risk adusted arb to owning a house versus renting for a long term owner, perhaps due to the aforementioned mortgage and tax subsidies. I guess if on allows for dislocation in the commerical real estate market, then the potential exists there as well. But the implication would be that the mere act of investing in the fund would result in an increase in NPV/wealth, which is a fairly bold assumption.
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Re: Rejoice! Your House Is An Investment Again

Postby Rolyatroba » Fri May 10, 2013 11:32 am

avalpert wrote:And you are not really following the thread or understanding NPV's limitations. I referenced WACC because Valuethinker did - but I'm not sure it is obvious that expected ROI of your nest egg is the right discount rate for an individual to use in NPV calculations. Putting aside again how bad we are at projecting what that ROI will be, there is nothing to suggest that your nest egg and the house have similar risk profiles so why would that be the right discount rate?

Anyone making financial decision should learn about the limitation of NPV, why business don't make decisions using it in isolation (and neither should you), and understand why you should be very wary of reducing financial decisions to a single number when the assumptions that go into deriving that number have large uncertainty bars.


This thread isn't about NPV limitations. It started with the premise that while a home may not be a good investment, it beats paying rent; then it morphed into the predictability of real estate values. My initial post addresses the former.

When one is actually faced with making a rent vs. buy decision, or any other decision that involves future cash flows, one would be foolish to dismiss NPV as part of the decision process (I never advocated NPV being used exclusively--of course there are subjective components to such a decision).

While there is great difficulty and disagreement about risk profiles of the assets, the individual can make their own assumptions and plug into the NPV model to at the very least find glaring problems.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Fri May 10, 2013 12:03 pm

Rolyatroba wrote:
avalpert wrote:And you are not really following the thread or understanding NPV's limitations. I referenced WACC because Valuethinker did - but I'm not sure it is obvious that expected ROI of your nest egg is the right discount rate for an individual to use in NPV calculations. Putting aside again how bad we are at projecting what that ROI will be, there is nothing to suggest that your nest egg and the house have similar risk profiles so why would that be the right discount rate?

Anyone making financial decision should learn about the limitation of NPV, why business don't make decisions using it in isolation (and neither should you), and understand why you should be very wary of reducing financial decisions to a single number when the assumptions that go into deriving that number have large uncertainty bars.


This thread isn't about NPV limitations. It started with the premise that while a home may not be a good investment, it beats paying rent; then it morphed into the predictability of real estate values. My initial post addresses the former.

When one is actually faced with making a rent vs. buy decision, or any other decision that involves future cash flows, one would be foolish to dismiss NPV as part of the decision process (I never advocated NPV being used exclusively--of course there are subjective components to such a decision).


Hmm, you did say:
With NPV, this topic becomes trivial. Someone thinking of purchasing a home should estimate the future cash flows (including tax-related flows), and compare that with the NPV analysis of the cash flows related to renting. The alternative with the higher NPV wins.


Which sure sounds like advocated using NPV as the exclusive basis for making a decision. And of course the predictability of real estate values is an important part of determining if it beats paying rent (you can't ignore the terminal value of the asset, even in an NPV calculation).

While there is great difficulty and disagreement about risk profiles of the assets, the individual can make their own assumptions and plug into the NPV model to at the very least find glaring problems.

But ultimately this is the real problem I have - the glaring problems they won't see are the ones with their assumptions and those are the most important. In this decision in particular, people tend to underestimate the maintenance costs associated with a house, they tend to overestimate the asset appreciation, they tend to ignore the unpredictable variation in the cash flow required for maintenance (using an average is a particularly good way to make a bad decision when the difference between having to replace the roof in year 2 and year 30 can have such a big impact on an NPV calculation) and they tend to under-appreciate the difference between the risk the owner takes and the risk a renter has.
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Re: Rejoice! Your House Is An Investment Again

Postby Rolyatroba » Fri May 10, 2013 12:20 pm

avalpert wrote:Hmm, you did say:
With NPV, this topic becomes trivial. Someone thinking of purchasing a home should estimate the future cash flows (including tax-related flows), and compare that with the NPV analysis of the cash flows related to renting. The alternative with the higher NPV wins.


Which sure sounds like advocated using NPV as the exclusive basis for making a decision. And of course the predictability of real estate values is an important part of determining if it beats paying rent (you can't ignore the terminal value of the asset, even in an NPV calculation).


I could have worded better...some of the inputs are not trivial to estimate. But it is a long-term decision, people are frequently faced with such decisions, and objective analysis is required as part of the process--NPV is a very simple, accepted method to use.

avalpert wrote:But ultimately this is the real problem I have - the glaring problems they won't see are the ones with their assumptions and those are the most important. In this decision in particular, people tend to underestimate the maintenance costs associated with a house, they tend to overestimate the asset appreciation, they tend to ignore the unpredictable variation in the cash flow required for maintenance (using an average is a particularly good way to make a bad decision when the difference between having to replace the roof in year 2 and year 30 can have such a big impact on an NPV calculation) and they tend to under-appreciate the difference between the risk the owner takes and the risk a renter has.


Certainly, NPV is limited if future cash flows are omitted. So, what about for very simple examples, say a mortgage refi? Would you then advocate using NPV in that analysis?
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Re: Rejoice! Your House Is An Investment Again

Postby swaption » Fri May 10, 2013 2:00 pm

avalpert wrote:But ultimately this is the real problem I have - the glaring problems they won't see are the ones with their assumptions and those are the most important. In this decision in particular, people tend to underestimate the maintenance costs associated with a house, they tend to overestimate the asset appreciation, they tend to ignore the unpredictable variation in the cash flow required for maintenance (using an average is a particularly good way to make a bad decision when the difference between having to replace the roof in year 2 and year 30 can have such a big impact on an NPV calculation) and they tend to under-appreciate the difference between the risk the owner takes and the risk a renter has.


Come on now, you can't go here. If we're going to play nice in the sandbox I suppose we should all assume that this whole thing is only about as good as one's assumptions. Take home price appreciation for instance. If it's me right now, I think the expected inflation rate of let's say 2.25% might be about right. Even this puts the net cost of mortgage debt (assume interest rate of say 3.5%) at just slightly above 1%. Even just a little real appreciation gets you into the realm of wacky valuation land as the net carrying cost (aside from maintenance, etc.) trends towards zero. In terms of all the other stuff, not everyone has to lie to themselves. After all we sit here and advocate index funds even though the vast majority of people out there think they can time and beat the market. But that doesn't mean we collectively throw in the towel on what should otherwise be a sound approach.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Fri May 10, 2013 2:09 pm

swaption wrote: After all we sit here and advocate index funds even though the vast majority of people out there think they can time and beat the market. But that doesn't mean we collectively throw in the towel on what should otherwise be a sound approach.

Not at all, definitely don't need to throw in the towel. What is does mean is that we decision decision processes that recognize our intentional and unintentional biases that trip us up. That is why I think it is a bad idea to suggest just doing an NPV calculation for home buy vs rent decision - or for that matter just use one of the many simplified calculators online that do the same thing. All that does is allow you to mask the truly important questions of your assumptions you need to ask.

swaption wrote:Come on now, you can't go here. If we're going to play nice in the sandbox I suppose we should all assume that this whole thing is only about as good as one's assumptions.

See this is the point. It is only as good as one's assumptions and we are too quick many times to take our assumptions at face value, put the into a fancy mathematical model and accept what is spit out as gospel. I've made a nice living consulting corporate finance, strategy and risk functions to get beyond those poor decision making tactics and it shouldn't be any different for individuals.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Fri May 10, 2013 2:11 pm

Rolyatroba wrote:
Certainly, NPV is limited if future cash flows are omitted. So, what about for very simple examples, say a mortgage refi? Would you then advocate using NPV in that analysis?

Sure, though again not if it comes at the expense of considering assumptions about say future rates (if you are using an ARM of some sort), or early repayment penalties etc.
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Re: Rejoice! Your House Is An Investment Again

Postby swaption » Fri May 10, 2013 2:54 pm

avalpert wrote:
swaption wrote: After all we sit here and advocate index funds even though the vast majority of people out there think they can time and beat the market. But that doesn't mean we collectively throw in the towel on what should otherwise be a sound approach.

Not at all, definitely don't need to throw in the towel. What is does mean is that we decision decision processes that recognize our intentional and unintentional biases that trip us up. That is why I think it is a bad idea to suggest just doing an NPV calculation for home buy vs rent decision - or for that matter just use one of the many simplified calculators online that do the same thing. All that does is allow you to mask the truly important questions of your assumptions you need to ask.

swaption wrote:Come on now, you can't go here. If we're going to play nice in the sandbox I suppose we should all assume that this whole thing is only about as good as one's assumptions.

See this is the point. It is only as good as one's assumptions and we are too quick many times to take our assumptions at face value, put the into a fancy mathematical model and accept what is spit out as gospel. I've made a nice living consulting corporate finance, strategy and risk functions to get beyond those poor decision making tactics and it shouldn't be any different for individuals.


Ok I don't get it. So what do you do? Let's say you are put in a position of considering home ownership, how do you approach this? It sounds like you are saying any form of fundamental analysis is futile. If it's me, I kind of like those simplified models, if for no other reaosn I don't think this is all that complicated. I hear what you are saying about the assumptions. But once again I probably beat that simplified model up a bit, perhaps putting in assumptions regarding appreciation and maintenance that are barely on the edges of rationality. At a certain point you need to make a decision. Do you just throw up your arms and blindly throw you money in based on some misguided perspective that this is all really just some "lifestyle" decision? In hindsight, probably not the most prudent approach for those engaged in this process circa 2007.
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Re: Rejoice! Your House Is An Investment Again

Postby Rolyatroba » Fri May 10, 2013 5:01 pm

swaption wrote:
avalpert wrote:See this is the point. It is only as good as one's assumptions and we are too quick many times to take our assumptions at face value, put the into a fancy mathematical model and accept what is spit out as gospel. I've made a nice living consulting corporate finance, strategy and risk functions to get beyond those poor decision making tactics and it shouldn't be any different for individuals.


Ok I don't get it. So what do you do? Let's say you are put in a position of considering home ownership, how do you approach this? It sounds like you are saying any form of fundamental analysis is futile. If it's me, I kind of like those simplified models, if for no other reaosn I don't think this is all that complicated. I hear what you are saying about the assumptions. But once again I probably beat that simplified model up a bit, perhaps putting in assumptions regarding appreciation and maintenance that are barely on the edges of rationality. At a certain point you need to make a decision. Do you just throw up your arms and blindly throw you money in based on some misguided perspective that this is all really just some "lifestyle" decision? In hindsight, probably not the most prudent approach for those engaged in this process circa 2007.


Can you answer avalpert? I would like to know how you'd approach a rent vs. buy decision without NPV analysis. I am not a corporate finance professional, so I'd be curious what other methods are out there (besides the Finance 101 methods I know about, such as break-even, IRR, etc.)

I've used NPV on numerous occasions, both personally and professionally (the latter working with finance people at different places of employment), and that has always been a good base for understanding the financial part of a decision. I've also used the "Analytic Hierarchy Process" for more complex decisions, typically involving psychological factors.
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Re: Rejoice! Your House Is An Investment Again

Postby azanon » Sat May 11, 2013 8:42 am

If a house is an investment, then this would be my advice to my fellow bogleheads; Try to hold as little of this "investment" as possible, while meeting your families needs and happiness. I'll let you decide whether that advice implies that it really isn't an investment, but an expense.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Sat May 11, 2013 3:35 pm

swaption wrote:It sounds like you are saying any form of fundamental analysis is futile.

Not futile, just limited and needs to be kept in perspective.

Ok I don't get it. So what do you do? Let's say you are put in a position of considering home ownership, how do you approach this?

There are a few things I would do. First, I want to truly test affordability - not just can I cover mortgage/taxes/utilities/insurance/routine maintenance and upkeep etc. from cash flow but how stressed would the purchase make me if I lost my job, I needed to replace the roof today etc. Second, I want to lay out all my financial and non-financial assumptions and write them down - take a comprehensive list of all categories involved in a purchase decision and explicitly lay out what I'm thinking about them. It wouldn't suffice to say I am assuming an average maintenance cost of 2% a year - I need to justify why I am assuming that and then, at least for the bigger assumptions, both try to validate them and stress test the impact if I am wrong at different magnitudes. I would include here the 'lifestyle' assumptions that drive a purchase of a house as well (because it really is a lifestyle/consumption decision). Finally, I would run the financial analysis using the outside ranges of my confidence interval for all assumptions, compare it to my long term financial goals and weigh the value/cost against my lifestyle needs.


In hindsight, probably not the most prudent approach for those engaged in this process circa 2007.

In hindsight, someone who relied on an NPV analysis with appreciation rates based on 15 years of data in 2007 wouldn't have been taking a very prudent approach either. No analysis will guarantee you make the ultimately right answer, all you can do is ensure you are fully aware of the assumptions underlying your decision and are comfortable with them - preferably before you see how they actually impact the outcome.

Rolyatroba wrote:Can you answer avalpert? I would like to know how you'd approach a rent vs. buy decision without NPV analysis. I am not a corporate finance professional, so I'd be curious what other methods are out there (besides the Finance 101 methods I know about, such as break-even, IRR, etc.)

In a corporate environment the process is a bit different, but the idea is the same. Force people to make assumptions, and the degree to which you expect them to impact outcomes, explicit, make sure all decision makers are operating with the same assumptions, where possible create quick to fail tests of those assumptions and thier expected impact and iterate decision making as you learn where you went wrong. Most corporate lease/buy decisions are more straightforward than the assumptions that underlie a personal home purchase because they are already understood as consumption and not investment - though a surprising number of companies do a poor job at fully calculating total cost of ownership when making those decisions.
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Re: Rejoice! Your House Is An Investment Again

Postby swaption » Sun May 12, 2013 9:49 am

avalpert wrote:
swaption wrote:It sounds like you are saying any form of fundamental analysis is futile.

Not futile, just limited and needs to be kept in perspective.

Ok I don't get it. So what do you do? Let's say you are put in a position of considering home ownership, how do you approach this?

There are a few things I would do. First, I want to truly test affordability - not just can I cover mortgage/taxes/utilities/insurance/routine maintenance and upkeep etc. from cash flow but how stressed would the purchase make me if I lost my job, I needed to replace the roof today etc. Second, I want to lay out all my financial and non-financial assumptions and write them down - take a comprehensive list of all categories involved in a purchase decision and explicitly lay out what I'm thinking about them. It wouldn't suffice to say I am assuming an average maintenance cost of 2% a year - I need to justify why I am assuming that and then, at least for the bigger assumptions, both try to validate them and stress test the impact if I am wrong at different magnitudes. I would include here the 'lifestyle' assumptions that drive a purchase of a house as well (because it really is a lifestyle/consumption decision). Finally, I would run the financial analysis using the outside ranges of my confidence interval for all assumptions, compare it to my long term financial goals and weigh the value/cost against my lifestyle needs.


In hindsight, probably not the most prudent approach for those engaged in this process circa 2007.

In hindsight, someone who relied on an NPV analysis with appreciation rates based on 15 years of data in 2007 wouldn't have been taking a very prudent approach either. No analysis will guarantee you make the ultimately right answer, all you can do is ensure you are fully aware of the assumptions underlying your decision and are comfortable with them - preferably before you see how they actually impact the outcome.

Rolyatroba wrote:Can you answer avalpert? I would like to know how you'd approach a rent vs. buy decision without NPV analysis. I am not a corporate finance professional, so I'd be curious what other methods are out there (besides the Finance 101 methods I know about, such as break-even, IRR, etc.)

In a corporate environment the process is a bit different, but the idea is the same. Force people to make assumptions, and the degree to which you expect them to impact outcomes, explicit, make sure all decision makers are operating with the same assumptions, where possible create quick to fail tests of those assumptions and thier expected impact and iterate decision making as you learn where you went wrong. Most corporate lease/buy decisions are more straightforward than the assumptions that underlie a personal home purchase because they are already understood as consumption and not investment - though a surprising number of companies do a poor job at fully calculating total cost of ownership when making those decisions.


So to paraphrase, you basically would do exactly what is being proposed, except you would do it better. Thank you for that valuable insight.
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Re: Rejoice! Your House Is An Investment Again

Postby avalpert » Sun May 12, 2013 10:10 am

swaption wrote:
So to paraphrase, you basically would do exactly what is being proposed, except you would do it better. Thank you for that valuable insight.


If what I wrote reads the same to you as:
With NPV, this topic becomes trivial. Someone thinking of purchasing a home should estimate the future cash flows (including tax-related flows), and compare that with the NPV analysis of the cash flows related to renting


Then sure, it is exactly what is being proposed. If you can' see the difference between simply comparing the outputs of a model rather than investing your effort in scrutinizing the inputs there really isn't anything more to discuss.
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Re: Rejoice! Your House Is An Investment Again

Postby hazlitt777 » Sun May 12, 2013 1:30 pm

Scooter57 wrote:If housing gets too expensive, people won't pony up more money, because they won't have it. They'll rent, which is what always happens with Real Estate. And the rents won't be enough to cover the costs of purchasing overpriced upscale housing, which is why the dream of getting rich flipping expensive houses only works when there are more flippers to sell to. You can't rent a lot of houses for more than what people making the typical wage in the region can afford. NYC and Silicon Valley are outliers. The median family income in the US is still somewhere around $50K. They call the 1% "the one percent" for a reason, and you are not going to get rich flipping houses that only 1% of people could afford to buy or rent. Flipping houses didn't work out so well in the 2000s, and I don't see any changes in the economy that make it any more likely to succeed now.

There's another factor that doesn't get discussed enough: People in their mid-20s to 30s with excellent jobs are carrying a much higher load of student debt (we saw the doctors discussing this in another thread here.) So they are not going to be able to pay monthly payments that represent a percentage of income comparable to those that an earlier generation bought at the same stage of their careers.

So it's very likely that the supposedly reawakening RE market is flippers buying from retirees and banks and trading with other flippers, which works until it stops working. What we aren't seeing the huge influx of first home buyers in their 20s and early 30s who are forming families and putting down roots that is what it take to get a real bull market in RE started. Real estate booms are sustained only when a lot of people in that household formation phase have good jobs and stable earnings. Until that happens, I'd be very cautious about buying real estate for any reason except that you find a house you want to live in (and pay for!) for many more years to come.


Well put.
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