...because I agree with you that the stock market over time should perform better than anything out there, as long as you do it systematically and not based on fear and greed. That's why I do dollar cost averaging. Each month I buy the same dollar amount of stock - when the price is low, I buy more shares, when the price is high, I buy fewer shares.
I've rented and owned. Renting was definitely less stressful for me (no monthly mortgage payments, property management hassles, fretting over value) until I had a family at which point the stability of being able to control where we lived clearly outweighed the economic advantages of renting. I own a house, but see it more as expenditure than an investment. Friends of mine in SF who just sold a house for $2.3M that they bought for
$2.8M four years ago definitely see it that way too, but for most of us the costs are not quite so obvious.
Yes, I've seen the NY times rent vs buy calculator. It is great - the best out there. But you need to be realistic in plugging in the variables since you've got to assume certain appreciation rates for houses and the stock market. When you do that, you'll find that renting is cheaper because over any meaningful period of time because the stock market (including paid dividends) appreciates faster than the real estate market (and homes generally appreciate at a lower rate than the interest on funds borrowed to purchase them). These differences in appreciation work to the disadvantage of homeowners over time, although the impact of the transactions costs (i.e. the realtor's 6%) really hits you if you sell within a few years. And don't forget your home can actually decline in market value (we've learned that lesson now, right?) whereas the principal amount will not (except to the extent you actually pay it, of course).
Anytime you buy instead of rent, time works in your favor. The peace of mind that as time goes by, your decision is getting better and better is much peaceful than the other case of renting, where as time goes by, your decision is getting worse and worse.
Money isn't the only factor here. Your stress level is a very big factor in your quality of life. I've done both -- I've bought a house and just let it appreciate .... and I've decided not to buy a house and spent many early mornings and late lunchtimes trying to time the stock market. People always brag that they make a killing in the stock market, but most of those people fail to mention that over time they've also lost money too and stressed out over their computer when they could have been relaxing or doing something more enjoyable. Maybe they put their money with a money manager, but then they are paying a fee to the money manager.
The best happy medium is to at least own the house you live in. If you still are not convinced that investing in real estate is right for you, then just own that one house you live in to avoid rent, but don't buy any 2nd or 3rd house for investment.
I personally believe in real estate as an investment. That's why I'm in real estate even though I have a high tech degree which could be earning me a pretty safe, relatively high income. However, even though I like to buy real estate for myself, I never push my buyers to buy. My job is to help you do what you want to do.
You have to go into "advanced settings" to adjust the other parameters because the tool is not set up for California values.
What makes this example so rare, is that the idea of buying a home and paying it off is not common right now. I have many clients who bought 30+ years ago, paid their homes off, and have been living mortgage free with 1978 property tax levels until they are ready to move on or die. They also have 1million plus in equity and a place to call home. If they had used their 20-60K plus interest to invest in the stock market maybe they would have more money, but maybe not. They would though never have the security of owning their own home.
If you buy a home you can not afford there is no security, but if you do not buy a home but instead rely on the whims of the rental market your life can be more disruptive than I personally would want.
If you add to that the long term appreciation, principal payments as forced saving, and tax benefits then for many people real estate is a good option. The key is to not have too big a loan and pay it off!!!!
Marcy, I think anecdotes like your first client's sound much better than they really are. First, 1995 was right before the big run up in housing prices due to the tech boom. So the timing off your first client's purchase was particularly fortuitous. Or smart, if you believe that they intentionally timed their purchase then, as opposed to renting for 4 years and buying right before the tech bubble burst.
Putting that aside, if your client now has $1.5M in equity in a home worth $1.5M, I assume he paid off all of his $400K mortgage in 15 years. Mortgage rates in 1995 were around 8%, so if he took out a 15 yr. fixed, mortgage payments alone would have been $3,800/month. That's far, far above what the rental value would have been for a $500K property -- probably below $2000/month way back then.
But ha, you say, all those payments went toward an investment that tripled in value form $500K to $1,500K. True, but that's an annual return on investment of 7.1%, which is LESS than the 8% mortgage he's paying. So he's borrowed money to purchase something that appreciated at a lower rate than he borrowed. That ain't no way to make money, obviously. Remember all those $3,800 monthly payments...
Well, you say, that's better than putting it in the stock market. Perhaps, but he wouldn't have had to borrow money at 8% to invest in the stock market. He could have simply used the $1,800 per month he'd have saved by renting. And anyway, if you just put it in a Nasdaq Index fund you would have done better than "investing" in your home: in May 1995 the Nasdaq was at 858, now it is at 2,873, for a 330% increase or about a 7.9% annual return. And this is without taking into account the dividends paid out during this 16 years (I just couldn't find that stat).
Sure, he probably refinanced his loan, rental rates have gone up too, and you can deduct interest etc. but he also probably remodeled at some point, replaced the roof, paid his gardener, paid fees to refinance, will lose 6% to the realtor, faces AMT and paid property taxes. My point is, to borrow a real estate metaphor, that the economic "bones" of homeownership aren't as great as they seem, even in Palo Alto, even during the biggest run up in the history of the state, even in the price range that likely saw the greatest appreciation.
Markets are pretty efficient, I think, and people kid themselves into thinking home ownership is "great deal" compared to renting as if the price they pay somehow doesn't have baked into it the exact same economic expectations all the other bidders have.
I've run many different scenarios and I have come to the same conclusion as you. Purely from a financial standpoint, you never see a positive return when you take into account the opportunity cost of capital.
I happened to have sold my home when the market was frothy. After considering upgrading, I simply rented a larger home.
Kudos to you Marcy on seeing your mistake with the figures. Your point is well taken that you should count the appreciation on the downpayment and expenses. Also bear in mind, that the mortgage deduction generally does not apply to home owners in palo alto as it is obviated by AMT rules.
You are correct in that after 30 years you will have a home that is paid off. However, you would have accumulated 2-3X more wealth by renting the same or comparable home over the same time period. Another way to look at this is that homes historically only apprieciate at 1-2% annually, which essentially keeps pace with inflation. You don't lose money, but you don't make much money either.
Keep in mind that US inflation is likely to rise big time in the next few years with the deficit issues, so even if it is overpriced now, it could be a cheap mortgage looking at the long term -- 10 years plus.
For more info see my blog about whether now is the right time to buy. Link below. Good luck.
I do see what I think is your point, btw, about appreciation on the down payment, i.e., say, when a $1M property appreciates 10% and you've only put $100K down, your return on investment is 100%. But that only works if the rate you borrowed money at is lower than the rate the property appreciates at.
Having said all that, I doubt the seller of 1102 Emerson could have rented that nice of a place for 7 years straight in Palo Alto -- the owner/landlord would have sold it or moved back in or something.
I just looked at my figures and I agree I have no idea what I was saying on this one. My point was the appreciation should be on the down payment and expenses not the cost of the house, but I need some ore time to figure out what I did yesterday.
I still maintain that
paying off a house is a great idea, but I thought they did ok on this short term investment. I think I am wrong here.
the more expensive the home the less advantage you get in buying over renting.
I know nothing about the stock market so investing in stocks for someone like me would be closer to gambling than investing.
Home ownership is not for everyone, but for those who want it there is a way to buy smartly, and a way to buy stupidly regardless of market conditions.
I will revisit these numbers when I have a little more time. Sorry for the mistake!!!!!
1. I agree with you here.
3. Disagree, mildly. Realtors fees would be $111K, not $100, but you're close enough to justify the easy math I suppose.
4. Disagree, midly. The difference between rent and mortgage would be for 7 years, not 6 (April 2004-April 2011). And I think it is fair to assume that this difference in payments would have been put into, say, a Nasdaq index fund which from April 2004-April 2011 had a cumulative annual growth rate of about 5%. The future value of this income stream of 7 years would be closer to $300K, not $275k. But I suppose you're close enough since arguably he also could have invested in JDSU or Qualcomm and lost a bundle! Anyway, the success a renter has in investing the money he'd otherwise put into a down payment and mortgage payments (see my point 6 below) seems to be a very key variable here.
6. Disagree. Per 3 and 4 above, I come out with "expenses" about 36K higher than you. More importantly, I think it is fair to take into account the money he would have otherwise made on the $275K downpayment: assuming a 5% compound annual growth via a Nasdaq index fund it would be worth $386K (i.e. by putting the money into the house he lost the opportunity to make another $111K in profit (386 minus 275)). So his total "expenses" for 7 (not 6) years are $750K plus $36K plus $111K = or $897K
7. Totally disagree! You said the "total profit: $615,000." I didn't understand the derivation of this. Perhaps you forgot he's got to repay back the bank? As I see it, there's no profit at all here: $1,865K (the sale price) MINUS $1,100K repayment of principal to the bank MINUS $896K in "expenses" for a net LOSS of $131K compared to renting.
We could quibble about whether my $897K guesstimate in "expenses" is more accurate than your $750K guesstimate, and I suppose some portion of the principal would be paid off during the 7 years of mortgage payments (even though they are heavily front loaded with interest). But still, he has likely lost money here I think, even though he sold at a higher price.
1. Purchase price in 2004 for $1,375,000 with a loan of $1,100,000 so $275,000 invested
2. $100,000 for remodel (assuming that figure)
3. $100,000 cost of sale
4. $275,000 for difference between rent and mortgage for 6 years (using $3000 a month more for mortgage. No tax benefits counted because of property tax and expenses)
5. Sale for $1865000
6 Total expenses for 6 years $750,000
7. Total profit: $615,000
So a profit of $100,000 a year seems pretty good to me on an investment of $750,000
This is in a time frame which I think is too short so I do not recommend trying to do this every six years, but my point about appreciation is that you have invested the amount for the down payment, not the full price of the house.
Public records show the seller (apparently a ex-marketing exec who founded a mobile gaming co) had a $1,100,000 mortgage, and I think rates back in 2004 were around 6%, so clearly if the annual appreciation was 2.75%, the seller lost money (yes, I'm aware of the interest deduction, but that's more than offset by taxes, and other owner expenses) He may feel great about his capital gains on the property, and no doubt realtors see this a confirmation that a home is a great investment, but I don't think that's the case here -- the owner has been bleeding cash for 7 years to finance this "investment".
Things get more complicated if you want to do a rent vs buy calculation, but I note his mortgage payments alone were around 7K per month, almost double what that place would have rented for in 2004.
Sorry for the delay in answering. Long term means at least 10 years, but preferably buy a house, pay it off, and then own it. That way the ups and downs over the years are less important than actually owning an asset at the end, which can be lived in, rented, sold if needed to support your retirement, or passed down to heirs. That is what I believe in and why I sell real estate, not to make a quick profit (or loss) in 5 years. I do not know what will happen in real estate in the short term, any more than anyone else does. It goes up and down, but I believe in it over the long haul, and have my own money where my mouth is as well as helping other people buy and sell.
All those benefits you describe can also be wrought by renting in the same area. I have numerous colleagues that fell into the housing trap in the past 5 years in the peninsula. They are not exactly thrilled with their purchases...
No need to buy the cow when you can get the milk for free.
You have to live somewhere and whatever your other housing cost is, should be factored into the equation. For some people, living in Palo Alto offers unique opportunities in the relationships you make-ones that can further your career, give you a tip on a new technology, etc. It's like living in Manhattan-to some the cost is ridiculous, to others it's worthwhile to live in the heart of what's happening in that unique part of the world.
How would you define a long term outlook in palo alto, more than 5 years, more than 10?
I am not sure what is the implication that you would only sell in a market you thought would appreciate. You have no financial consequence regardless whether homes appreciate or depreciate after the sale.
Is this to imply that realtors in declining markets are less trustworthy? That would encompass your colleagues in most of the bay area.
I believe that Palo Alto homes will hold their value and appreciate in the long run. If I did not believe that I would not be selling real estate in Palo Alto. However, I do not believe that leveraging to buy real estate is the best way to maximize your investment. I think people should buy, hold, pay off and own outright. I also believe there are a lot of benefits to owning real estate and being in charge of where you live, but not everyone feels that way. I am Pro Choice. I would never try to convince someone to buy, but if a consumer wants to buy then my job is to help them buy the with the best terms and price I can get for them and help them understand the plusses and minus of that particular home.
I think you misunderstood my question...As the original poster noted, it is far from clear whether homes selling in palo alto <2M will hold their value, let alone appreciate and have a return similar to years past.
Do you think the sales rate will show price increases of more than 6% to make up for financing, taxes and maintenance costs over the next couple of years?
I've run various scenarios on the NY Times rent v buy calculator. If you assume prices in PA will increase by 4% per year (the range over the last 15 to 20 years is 4-6%), the stock market will increase by 6%, and rent increase will slightly lag house increases at 3%, then it never makes economic sense to buy -- even if you hold for 30 years.
Of course those are big IFS -- it you tweak any just a small amount, you can get very different out comes.
Back up North where I'm more familiar, you definitely see such white elephants as 1150 Parkinson that were built 2 years ago and never sold now being offered at $3M. I forget exactly what the asking price was in 2009 (and Redfin doesn't show it), but I'm sure this is a huge discount. It would appear the owner/developer got hosed here.
As for Matthew Holder, it appears he's now at Trulia: http://www.quora.com/Matt-Holder
As for jonp, I always suspected he was Matthew's alias, just spouting off to stir the pot. That would explain the radio silence now.
To the extent there is a facebook effect, I suspect it is small right now since 1) many of the big guns there already made their fortunes and have bought houses, 2) the smaller fry appear to have significant constraints on their ability to liquidate due to management policies and the fact that Facebook isn't public, and 3) it is offset by google's slow motion reversal of fortune. Then again, I only know googlers and not anyone at facebook.
My stats were from all of Palo Alto...not East Palo Alto (different city and different county). The data is for homes that were expired, cancelled, or withdrawn and not re-listed and sold in that time frame. Many may have come on the market again this spring.
MLS doesn't let me break it down by zip code so I can't help you on 94301.
You are absolutely right that the move up crowd has virtually vanished from Palo Alto, thereby leaving the larger homes in North Palo Alto much harder to sell than the smaller and relatively more affordable homes. According to MLS in 2009 there were 25 homes in the areas covered by the 94301 Zip code. (they break things down by areas on the past stats not zips) So the decrease in inventory is closer to 33% than 66% that is found overall. These are the homes that tended to be taken off the market because they seller could not get the price they wanted. so the only question is when will they come back on? My feeling is not this year.
Among people I know in PA, no one is thinking about "moving up". If they want more space they are remodeling -- construction costs are 60% of what they were during the boom.
94301 is 40 listings and about the same in terms of recently sold, pending or active.
There is no relevant data to use from this information. Some of these may have sold after they went off the market. Other reasons: seller finds buyer, buyer finds seller, deal was about to be consummated at expiration, seller/buyer didn't want to share sale price so they asked to withdraw, seller testing the market - not serious, job transfer didn't go through, any of a bunch of other reasons why it was not sold - including it was overpriced in the first place or the location was completely intolerable to buyers in the market at that time).
You cannot come to any reasonable conclusions based on properties not selling. The absolute best way is to have the last 2-3 sales transactions for the same house over a 10-30 year period. That takes time and money but will give you a fair idea as to appreciation, etc. You'd have to compile a bunch of these for the same area, account for remodeling and additions, and look at economic trends (inflation, tax rate changes, unemployment, interest rate changes, etc.). Thousands of dollars for a professional appraiser to do this.
Expireds, cancelleds, and withdrawns are nothing more than non-events.
Mark Burns, Realtor
Coldwell Banker Elite - Top 1% Worldwide
DRE# 00896552 Licensed since 1985
Over 600 Homes Sold in Silicon Valley
Mark Burns, Realtor
Coldwell Banker Elite - Top 1% Worldwide
DRE# 00896552 Licensed since 1985
Over 600 Homes Sold in Silicon Valley
Why would people in the real estate business be shy about providing this sort of info? If there's a lot of listed places that got pulled unsold, wouldn't agents be eager to let SELLERS know this so they would be more realistic about their price (and thus generate more sales for the agents)? If the reverse is true (i.e. very few places unsold), BUYERS should know so they'll understand the market ain't gonna drop more.
Why do people buy?
2) Neighborhood (location, proximity to work, services, etc.)
3) You get to say you own it (and that is very important to a lot of people)
and way down at the end . . .
X) Tax benefits of writing off mortgage and property taxes
Y) Exclusion of capital gains taxes on appreciation
Z) Investment potential
No one says you have to buy a home. No says you have to buy a car. No one says you have to do anything. It's the opportunity to buy something that you can: live in, walk to parks nearby, send the kids to good schools close by, drive a short distance to work, enjoy nice weather, be close to restaurants and shopping, live near people you like, etc. That's why people buy. If you have to analyze it and say no; that's your choice. No one says you have to buy a home.
Why the concern about others making choices about what they want to do? Some people may feel like they've made a mistake in buying a house at the wrong point in the market. How would they know unless they could see the future? How many people bought homes with little thought about future appreciation and then found out they had made a lot of money on the house? Some folks might say they don't care. Some folks may drive home everyday, pull into the garage and say, "It's great to be home and it makes me feel good that I own it."
If the point here is to warn people about being careful in buying a house, that's been accomplished.
Mark Burns, Realtor
Coldwell Banker Elite - Top 1% Worldwide
DRE# 00896552 Licensed since 1985
Over 600 Homes Sold in Silicon Valley
But I'm curious how many places that were listed and then taken off the market over the last couple years are going to come on line this spring. Are there stats anywhere on how many listed places never sold?
All of that being said the value of homes in Palo Alto have held up pretty well compared to other places. I speak to realtors all over the country who are working in areas where 50% depreciation is the norm. Except in some of the very high end properties in PA we had closer to 20% depreciation, and now prices appear to be on the rise again. The inventory is incredibly low this year which is helping to drive prices up. They are not back to 2007 levels, but going back up.
Thanks for your thoughts. I believe your assumption of "50K loss after taxes" is a big one, though when I ran the numbers slightly differently, my end result wasn't that much worse than yours. But don't forget you've got to take into account the 6% sales commission which would be over $110K alone on the current ask of $1.895.
Clearly, the 1999 purchaser lost money any way you look at it. Per propertyshark, he/she borrowed $1M, at probably around 6% and the house didn't appreciate at all in 5 years, net of the 6% commission to the realtors. Property tax and maint would have offset most if not all of the tax deduction on the interest. So he was paying roughly 60K a year interest, or about 5K per month for a $1.3M property. I know from personal experience that a nice $1.3M property in PA right now will rent around $3,200 per month, give or take $100. So that's $1,800/month extra that the 1999 owner paid in interest, or about a $100K extra over 5 years. Not the end of the world, but a loss nonetheless when everyone around him was saying renting is throwing money away. Basically, he traded the ability to live in a much nicer $5,000/month rental (of which there are plenty) for the emotional/social satisfaction of being a homeowner. Not a foolish choice, but one with a cost.
The 2004 purchaser could do better, at least if he's able to sell at his $1.895M asking price. He had $1.1 in loans, also probably around 6%. Appreciation was $500K, minus $100K (assumed) for the remodel, minus $110K realtor commission for a net appreciation of $290K over 7 years. If we assume the 2004 purchaser paid the same $1,800 per month premium over renting that the 2000 purchaser did, then over 7 years that's about $151K extra that he paid over 7 years to buy instead of rent. Offset that against the $290K in net appreciation on the house and you have a net, net appreciation of $139K over 7 years. The 2004 purchaser has come out ahead, but not by much. And I could definitely see that house going through a price reduction that would wipe out that $139K and then some.
And don't forget that all the above calculations don't include closing costs, repairs, points, opportunity cost of tying up the down payments, homeowners insurance, the cost of renting a place during the 2004 remodel, etc...
I'd agree with you Marcy that paying off your home after 30 years is a nice plan, but one very, very few people can realistically expect to follow. I think economically the real reason it makes sense is because you lock in a ridiculously low tax rate, albeit at the expense of our children and immigrants.
I think the big problem with not enough appreciation happened in the 1999 sale, right before the dot com bust. The house listed for $979,000 and sold for $1.3000 So then when it sold in 2004 for 1.375 there was virtually no appreciation because they had paid so much 4+ years previously. So between 2004 and 2011 there was a about a 500K appreciation. Assuming a 100K remodel cost (which I have no idea if that is high or low) then you get 400K in appreciation. During that time period they got to live in the house and take the tax deduction for the mortgage and taxes. I am going to assume a 50K loss after taxes over what they could find as a rental. That figure may be off but i have no idea what king of mortgage, interest only, fully amortized, etc. So let's say they made 350K over 7 years or 50K a year on an investment where they have let's say 500K into it. Again I am making up the 500K into it but it is based on a reasonable downpayment, negative cash flow over rental costs, taxes etc. so a 10% return sounds pretty good to me.
That being said, homeownership is not for everyone. You should only do it if it is a long term investment, not a short term money making investment. Also, as I have said over and over again on this forum, if you are going to buy a home it is best to get a 30 year loan and pay it off so at the end of the term you own the house and are not just renting from the bank and hoping for appreciation.
I did and I know others who also did. It's simple - buy low, sell high.
The reality is Palo Alto is a very desirable area and will hold value to those who had the means to purchase. They will be affected by the buyers who should not have been purchasing - on margin - outside of their income (interest only).
When you are looking at prices the value is what a ready willing and able buyer offers. An appraiser can also help a buyer understand the value along with their agent.