LFKB wrote:wilked wrote:LFKB wrote:
Your car analogy is ridiculous. It's a depreciating asset vs. a home which can be lived in forever and which should appreciate.
The house is definitely a depreciating asset. You may think it should appreciate, but history disagrees, in spite of recent run-ups... Google inflation-adjusted housing prices, there are tons of links out there
If your taxes on your house = current rent, I can assure you there are significant savings to be had by renting. A very graphical way to look at it is here
http://www.nytimes.com/interactive/2014 ... .html?_r=0
I googled inflation adjusted housing prices, they have appreciated in real terms, albeit at a slow rate. Comparing a house to a car which depreciates 30% when driven off the lot and has a useful life of probably 7-10 years is a bit ridiculous in my opinion. I never said I am anticipating significant appreciation in the home, but comparing it to a car depreciation isn't reasonable.
I played with the rent vs. buy calculator. It says I would need to rent a similar place for ~$7,000 a month to make renting a better deal, which is likely not doable.
We need to think about this rigorously as possible-- this is finance.
The equity you have in a property is an alternative to imputed rent.
What I think you will find is that rents have risen, but home values have risen in coastal USA a lot faster. Thus the cap rate has declined significantly. This is a combination of:
- zoning controls which make it hard to build more housing in high demand areas (NY/ Boston/ Bay Area/ SoCal)
- a change in overall market interest rates (down)
The first is likely to continue, the second less so (and could reverse). Both Japan and Germany have experienced real falls in housing prices since the early 1990s. The US has less mature demographics (but immigration controls play a role in this) and deflation is arguably less of a risk.
It is very instructive to look at what happened to housing prices 1920s to 1940s. In many parts of the USA they peaked in the 1920s and didn't recover for 20+ years (in real terms). OK so we don't *think* Los Angeles is the next Buffalo or Baltimore (both of which have absolutely amazing architecture) but we cannot be sure of that.
On actual housing prices, Shiller (and others) found that housing prices didn't keep up with inflation, adjusting for quality. See Neil Monnery 'Safe as Houses: 8 centuries of housing prices' for a broader look at the data (but also see Shiller's website at Yale).
However in coastal areas the last 40 years they have comfortably beat inflation (see Edward Gleaser's work).
What we can say is that:
- structures depreciate over time. That depreciation may be as much as 1-2% pa. Houses are not worth more as they get older, because you have to spend to keep them up to date (in commercial structures the depreciation rate is 2-3x that). In that sense a house *is* like a car (albeit with a much slower depreciation rate). It is a depreciating consumer durable
(if you go round homes and see some ones that haven't been touched in 30-40 years you'll see what I mean. Old wiring etc. 40 years ago Air Conditioning wasn't universal, and it was on a different level in terms of comfort and convenience even if you had it. Roofs need constant replacement. Driveways and decking. Even in the last 10-15 years it's standard for new homes to have home entertainment systems, fancy kitchens and family rooms etc. that were unknown 20 years ago eg it is common now for a cinema in the basement, temperature controlled wine cellar etc.). My mother's home is in a good area, but the house hasn't been updated since the 70s (except for necessary repairs) and the agents basically say the next buyer will *deduct* the cost of knocking it down from the purchase price. If you buy a $2.5m house more than 10 years since last total renovation, I predict you will spend $250k updating it.)
- land may, or may not, appreciate over time. Given the long run population and economic growth of the USA, the increase in housing prices has been surprisingly low (it's been much higher in the UK but, again, depends on *where*)
So past price appreciation may not be indicative of future price appreciation. Because the cap rate might not fall any further and/or rents might not rise as fast. I would add that a high quality neighbourhood is a 'low beta stock' in this-- the swings are not as large, generally.
Your investment in your house is your equity. The remainder of the purchase price, financed by debt, is a 'negative bond' in a sense, it's an inflation hedge.
My own view is that you are in a highly volatile profession. There are no certainties in private equity (google Candover and its torrid recent past for an example of one of the leading London PE firms for 2 decades, that blew up. Or Hicks Muse. Or Forstman Little). A *lot* of people have earned a lot less carry than they thought they would 10 years ago. Everyone I know who was in your sort of field:
- bought a nice house
- deleveraged as quickly as they could
There's a correlation between your personal income and the behaviour of financial markets. Having debt increases your leverage to that.
Once you have maxxed out tax exempt saving (and I assuming that's a trivial amount to you) then I would focus on debt repayment until you hit a level of debt (1-2x annual income?) that you are comfortable with, and that is on the safe side. Leverage is what you put into companies, not your own personal balance sheet. The only reason to have personal leverage is for liquidity reasons (it's hard to use your house equity as a bank account).
Remember if you have children your income may plummet (wife stops working) and your expenses will probably soar (nannies, private schools etc.).
The exceptions are borrowing to own equity in your firm, or for coinvestment in the fund portfolio (they usually arrange leverage with a bank for execs in that position). There, you have some influence over the outcome of your investing, so there's a case for gearing up to do it.
Note also higher interest rates are generally not good for PE investments (on the leverage side, the economics of deals shifts against you; conversely it may be a sign of a better economy). So you want most of your mortgage to be fixed, not variable, rate.