How Do You Know If Property Is Overpriced?

Here are my three:
1) Comps
2) Comps
3) Comps

An asset is worth whatever somebody will pay for it. The best proxy, until it actually sells, is the price somebody recently paid for a similar asset.

West81st, here's my answer to your three:

1) Inventory
2) Inventory
3) Inventory

because:

1) Comps change
2) Comps change
3) Comps change

So adjust the comps for changes in inventory, and any other trends that might affect value. That makes perfect sense: markets don't stand still, and comps lose their authority as they age. Personally, I prefer to estimate sale prices from actual sales rather than infer them from rents. Both methods have their uses, certainly.

Peace, out.

"So adjust the comps for changes in inventory, and any other trends that might affect value."

What might they be, and how to do it? I'm not aware of the technique.

History is a good thing.

Anyone considering listening to Steve as their real estate advisor ought to read first this discussion he started

http://www.streeteasy.com/nyc/talk/discussion/3410-real-estate-is-a-bad-investment

stevejhx- I did the math about a year ago for a place in LIC. It was clear that the units were grossly over priced. You could get the same unit (size, views and amenities) for about $2500/month cheaper. My analysis of LIC (example of a "it" area) shows that a $1M unit is over priced by at least $200,000-250,000. LIC is a great comparison because the units and views are virtually the same. It makes for some of the closest comparison between two units. I don't understand why it is so clear to some and not to others. I really don't have an idea.

They should read that thread, vverain, because I stand by every word: owner-occupied real estate is not an "investment"; it is capitalized rent.

And if you don't believe me that it's a bad investment, I invite you to read that link I provided:

http://www.globalpropertyguide.com/North-America/United-States/Rental-Yields

whereat you shall see, very clearly, the yield on investment property at last year's prices:

"Average yield is low in the US at 3.17%. Yields throughout the country range from 1.4%-5.5% The highest yields can be found in posh areas like Upper East Side and Upper West Side, Manhattan in New York. Southern California houses earn moderate gross rental income as well.

"Nationwide, rents fell by 0.4% in real terms in 2005, after a flat 2004 and a rise of only 0.61% in 2003. Between 1990 and 2005, rents rose by only 5% in real terms, compared to 49% real house price growth."

N'est pas a bad investment, when your 4.43% to 5.24%, on a risky asset (at last year's lower property / higher rent prices)?

Interesting, Steve stands by every word in that discussion topic

except ...

Just go to this discussion: http://www.streeteasy.com/nyc/talk/discussion/3768-preempting-steve
...where the same discussion link was provided and Steve acknowledged he was wrong ... see below

VVerain
7 days ago
ignore this person
report abuse WAIT A MINUTE ...
stevejhx
eah, don't you know my history? I did buy in 2003, but in Miami, where property prices went up higher and faster. I sold those for a mean profit. I also bought on Fire Island in 2005 b/c prices hadn't risen in 5 or 6 years.

I wasn't living in NYC in 2003. I will say this: I did not expect real estate to soar in Manhattan after 2003, and I was wrong. SEE I ADMIT I WAS WRONG! I made out just as well by buying elsewhere, but I didn't see at the time how the bubbles in real estate elsewhere were going to affect Manhattan.

When I came back to NYC in 2005 I started to look to buy, willing to pay up to $1000 psf in Chelsea or the W Village. Buthere were lines around the block for apartments, open outcry auctions, and I thought that was crazy, that it was a bubble, so I bought elsewhere.

...
and then remember this:
http://www.streeteasy.com/nyc/talk/discussion/3410-real-estate-is-a-bad-investment

stevejhx
7 days ago
ignore this person
report abuse And what's your point vverain? are you so ignorant as not to understand the subtleties of my argument.

Owner-occupied residential real-estate is not a good long-term INVESTMENT. I've always said that. But when it's UNDERPRICED vis-a-vis renting, then it IS a good investment. And if there's a bubble and you see it, then take advantage of it as long as it's at the beginning, and as long as you know when to get out.

Never have I said anything but that.

You can't even accept that I admit that I was wrong.

dco, they understand it. They think, however, that by insulting me and my arguments - without putting forth their own - they can sway readers. But by every single accepted valuation of real estate - price-to-rent, imputed rent, price-to-income - properties are way overpriced in NYC.

"Between 1990 and 2005, rents rose by only 5% in real terms, compared to 49% real house price growth."

That is unsustainable.

Vverain, your futile attempts to change the topic - since you can't provide your own numbers - won't work.

I think gold is a crappy long-term investment. If it costs $100 an ounce however, and I think it will go up in price to $1000 an ounce, will I buy it?

Yup.

I bought property to live in. I made a lot of money at it when I sold. I did NOT buy property to flip or for its appreciation.

So, get back to the topic. There are the numbers. Refute them.

remember DCO, according to Steve, "No matter how you slice it, renting is ALWAYS financially more beneficial over time than owning."

except that Steve has in the past and does currently own residential real estate (and he also makes 60% equity returns annually, "And yes, over the past 5ish year - that I've been paying attention, I've made 60% per year." http://www.streeteasy.com/nyc/talk/discussion/3733-listing-prices-falling-fast)

"No matter how you slice it, renting is ALWAYS financially more beneficial over time than owning."

If you look at it as an "investment," that is true.

Get back onto the topic, vverain: rather than try to insult me - an insult from the man who claims that housing is not a leveraged asset and that financial leverage (which produces income) is the same as mortgage leverage (which produces an expense) - show my why the 12x number is wrong.

Because you can't!

Steve, I'm not interested in refuting your argument. I've taken no position on the future direction of the real estate market in these discussions. I'm only interested in mocking you and your poorly constructed argument, flawed sense of logic, bad fact-checking, poor understanding of economics and makets, and loudmouth style of engagement.

Please indicate in this thread:

my poorly constructed argument
my flawed sense of logic (FYI logic is not a sense)
my bad fact-checking
my poor understanding of economics and markets.

It seems to me that "my poorly constructed argument" is supported with verifiable facts and figures.

That "my flawed sense of logic" is not such at all, as I've given you all the sources for my argument.

That "my bad fact-checking" also does not exist, since it's all transparent.

That "my poor understanding of economics and markets" is a projective identification from you.

I said, "show my why the 12x number is wrong," you answered, "I'm not interested in refuting your argument."

Because you can't. My argument is transparent, and not even mine per se: it's supported by history, theory, and data.

Steve, always very convenient how you jump to a new discussion topic (thread) when too many posters, whether they themselves are right or wrong, attack your positions on any given thread.

Why would I need to indicate "on this thread" all of your flaws when I've already pointed out on prior threads the same?

I thought not, vverain.

I think it was houser who told me, "Show me one good financial advisor who says it's better to rent than to buy." Now then, despite the oxymoron "good financial advisor," I would invite houser to show me where any reputable source would indicate that the p/e ratio of housing is other than 12x annualized rent, which at 8.5% interest rates for jumbo mortgages, is also the imputed-rent ratio - assuming short-term real price increases, which is also an unlikely scenario.

Someone show me where what I'm saying is disproved.

West81 - So comps based analysis says that the value of thing A, is what someone already paid for something reasonably similar to thing A, i.e. thing A-1.

Steve - So rent based analysis says that landlords can only get away with renting thing A at X/month, which means to purchase X out right you have to take X/mon * 12 * 12? X(12)(12) = actual value of Thing A and the price listed, if above Thing A is mere function of greedy over price-ed-ness(not a word, but you get the idea)?

Comps are what properties were worth yesterday, not what they will be worth tomorrow. Thanks to Wall Street, incomes rose precipitously in Manhattan in past years, so property price increases could be sustained (price-to-income ratio). Now incomes are falling. Ergo, prices must fall, too.

Property also rose in price because of loose credit (imputed rent ratio). That's being mopped up: credit standards are tighter, interest rates (especially for jumbos, virtually a necessity in Manhattan) are very high.

Property prices revert to the mean. The mean is a p/e of 12x annual rent. Now the figure is approximately 25x annual rent. There's no way to go but down.

Steve - gotcha. Ok, knowing that we don't know anything about Co-op sales until recently, do we know what this p/e number usually is? I assume that based on the math it is usually 12x (but one assumes that in the 80-90s downturn it was like, 10x, and now is it 25x so that it essentially averages out to 12x )

This means that prices have to come down by half, or people need to make more money (like twice as much?)?

Sorry for all the questions, last one for a bit. - So all these people with fancy mortgages, the mortgage gave them more money on paper so that they could buy apartments that were above 12x, but since everyone had a fancy mortgage, they all fought each other for the same apartments? there by making them more expensive (i.e. last bottle of water in the desert)? This somehow destroyed the banks in the precess and that is why Bear Sterns went under? Cause people borrowed too much money to pay for houses that they themselves were driving up the price on, which caused them to borrow more money? And when the music stopped they owed the banks more money than they had (or than the house could be sold for)?

Memnonhi: Regarding thing A and thing A(-1), yes that's essentially right, except that the price paid for thing A(-1) doesn't really tell you the value of thing A; it just allows to infer that value, with a varying degree of uncertainty.

Comp analysis predicts selling prices pretty well in most circumstances because buyers and sellers both tend to accept it. Most people figure that if the identical apartment down the hall sold for the same amount, the price can't be too far off. That may be faulty logic, but it's how most folks think.

Clearly, it's a good idea to supplement and validate your comps with the sort of fundamental analysis Steve is proposing. Otherwise, blindly trusting comps may simply cause you to emulate your new neighbors' stupidity. Also, you should consider external conditions that may have changed since a comp went to contract, especially mortgage rates and the availability of credit. You can try to factor in inventory and the overall state of the market too, but unlike mortgage rates, those influences are rather hard to quantify if they haven't affected comps yet.

Memnonhi: The Bear Stearns story is a bit more complicated, and so is the role of easy credit in the housing bubble; but you have the basics right. If you want to impress an Economics major, just call Bear's demise "a classic run on the bank", and be sure to mention that the Fed intervened because Bear was "too connected to fail". :o)

Comps do not predict the future, except by extrapolation, which is a logical fallacy. What predicts the future is the mean, and that is what I'm proposing.

Steve: I agree that comps are useless for predicting where a market will be at some arbitrary point in the future. But for predicting the sale price of a specific unit that's on the market at a particular point in time, comps are pretty much the only game in town, even if their predictive power is based on a widely shared fallacy that lacks any fundamental basis.

Your rent-based analytics may tell you where an apartment SHOULD trade, but they won't tell you where it WILL trade.

If I can purchase a Manhattan property that meets my specifications in terms of location and quality for 10% down, AND get some yutz like weasel-boy to pay me a monthly rent check that covers the mortgage and maintenance/tax amounts plus positive cash flow in my pocket every month, than it's not over priced.

"AND get some yutz like weasel-boy to pay me a monthly rent check that covers the mortgage and maintenance/tax amounts plus positive cash flow in my pocket every month, than it's not over priced."

I FULLY agree, malraux, and I've always said it. In fact, think about it: "to pay me a monthly rent check that covers the mortgage and maintenance/tax amounts plus positive cash flow in my pocket every month."

Translation: market rent = owner's carrying cost.

Once they're the same, that's the time to buy. And you will find that that is approximately 12x annual rent:

Let's say I make $100,000. I can afford to rent an apartment that costs $2,500 per month (40x monthly rent). I can afford to buy an apartment that costs me $2,333 total per month (28% of $100,000).

Now then, using the 12x formula, that same rental apartment should cost me $360,000 ($2,500 x 12 x 12) to buy. An 80/20 30-year fixed mortgage at 6.5% costs $1,820.36 per month. Add in $600 tax / common charges / maintenance per month, and what monthly figure do we have?

$2,420.36.

Miraculously between the $2,500 I can afford to rent or the $2,333.33 I can afford to buy.

That's why the formula works. Those are the market constraints. There are the numbers. Someone please refute them, tell me what I did wrong. Even malraux says that he'll buy an apartment if it's positive cash-flow - if he wants to buy an apartment to rent at $2,500 per month ($30,000 per year), it must cost 12x the annual rent, or $360,000, or less to make money.

Alas, right now, as far as I can tell, every apartment that SHOULD cost $360,000 is listed for $720,000 - 24x to 25x annual rent. That is why this is more than a bubble, and why the market MUST correct.

Unless I'm wrong and someone can show my why.

You fallacy starts with "Let's say I make $100,000. I can afford to rent an apartment that costs $2,500 per month..."

MY math starts with "This high end, very desirable two bed room condo cost me $2,500,000 as an investment property. I put 20% down. That leaves me a mortgage payment at 6.5% of about $12,500/month, plus $2,000 in maintenance/taxes, or $14,500/month. I rent the 2 bedroom for $17,500. So I make $3,000/month, someone else pays my mortgage and maintenance taxes, and in addition, over time the unit will increase in value.

"...That's why the formula works. Those are the market realities. There are the numbers. Someone please refute them, tell me what I did wrong..."

What you THINK every apartment SHOULD cost, and why the market MUST correct, are your ASSUMPTIONS, and not the market REALITY. Just like posting a thread inferring that prime Manhattan real estate is down 14.4% YOY, when the true reality is far, FAR less.

Unless I'm wrong and someone can show my why.

Malraux - the only difference I see between what you said and what Steve says is that Steve doesn't think someone will pay 17,500 for your apartment.

I mean, of course the numbers work if someone is willing to pay it. I don't think he is arguing that. I read his argument as "regardless of how nice your apartment is, you won't get people to pay 17,500 for it cause most people don't have 17,500 a month to spend on a two bed room condo." Now, you personally might get 17,500 for your condo, but I don't know if that is typical of the market.

And why is everyone so down on renters.....don't you want us to buy your apartment, or rent, why insult?

memnohni - don't think? It's not close to realistic.

Sure malraux, I'll show you why you're wrong. Here are the 10 most expensive 2-bedroom apartments currently listed in Manhattan on nybits:

$6,695 2-Bedroom at The Lyric
$6,795 2-Bedroom at Tribeca Park
$7,000 2-Bedroom at The Croydon
$7,000 2-Bedroom at Trump Place
$7,200 2-Bedroom at Trump Place
$7,495 2-Bedroom at 20 Park Avenue
$7,595 2-Bedroom at One Union Square South
$7,900 2-Bedroom at The Park Hudson
$8,000 2-Bedroom at One Columbus Place
$8,895 2-Bedroom at The Strathmore

Which one do you see costs $17,500 per month?

Then, let's see the price data for apartments with carrying costs of $15,000 per month (streeteasy's limit):

Sales in Manhattan
We found 951 listings with monthly payments of at least $15,000
Median price: $4,200,000 Median size: 2,328 ft² Median price per ft²: $1,861

So there you go: the median price is $4,200,000. But even picking the CHEAPEST of those $15,000+ per month apartments:

http://www.streeteasy.com/nyc/sale/106787-condo-117-east-57th-street-midtown-manhattan

You can still rent something identical for half the cost: the most expensive market-rate rental currently available at $8,895:

http://www.nybits.com/apartmentlistings/bc09553d9e11985a186185a601c9ddd9.html

"Just like posting a thread inferring"

YOU infer, I imply. Just a grammar FYI.

And your interest rate as way wrong - 30-year jumbos are currently being offered at 8.5% by BofA. If you use the short-term ARM rate, you have to adjust it for the reset risk, which premium is, of course, the exact difference between the ARM rate and the 30-year fixed rate.

The only apartments listed on this website for rent at $15,000+ per month are idiots like malraux who drank the real-estate Kool-Aid and are trying to recover their costs:

Rentals in Manhattan
We found no no fee listings for at least $15,000

There is one for $10,500 a month, however:

Rentals in Manhattan
We found 1 no fee listings for at least $10,000
Median price: $10,500

http://www.brokersnyc.com/listingemail/dsp_listing.cfm?aptid=24874&pub=1

PostWar Doorman, Elevator
Area Murray Hill
Building Name ***
Cross Streets Between Third Avenue and Lexington Avenue
Status off
Building Ownership Rental
Building Period Postwar
Rooms 10.0
Bedrooms 5
Baths 4.5
Rent $10,500
Security $10,500
Lease Term 12 months
Available 10/27/2006
Owner Pay 1 month
Levels Duplex
Year Built 1974
Corner Apartment Yes
Pet Policy No Pets
Floors 21
Garage Yes
Laundry Yes
Roof-deck Yes
Washer/Dryer Yes
Closets 11.0
Exposures S N W
Property ID 24874-1

Million Dollar Views of East River

5 bedrooms, 4.5 baths. The pros know what they're doing.

Malraux doesn't.

Steve: Why did you limit your search to no-fee apartments? There are 527 rental listings for $15K+, 521 in Manhattan.

In the $15K+/month price bracket, I think most customers are pretty insensitive to transaction costs, so fees probably aren't a big issue.

West81st, the reason I used no-fee buildings is because they are professionally run by experts who know what the market will bear. They NEED to rent those apartments at the market rate, else they are losing money.

Anybody can put a listing for $15,000 on streeteasy - for a studio, even. That doesn't make it a market rate; it makes it the rate that the owner wants, perhaps to recover his costs.

Which is why it is so relevant that there are 527 rental listings for $15k for individual units, and zero for professionally managed buildings. Ask what you want - the market does not bear it.

There aren't managed buildings with apartments worth $15,000

if no one buys it, it has been overpriced

lintintin, that was probably the most astute statement i've read on this board in months.

While I agree that Malraux is unlikely to get his 17.5 monthly, stevejhx, leaving out 527 rentals that could weaken your argument is onerous. And while I enjoy your pontificating, to a point, such manipulation
of data available, and your untenable argument of why you were justified, undermines all of your arguments.

"if no one buys it, it has been overpriced"

Wow! What genius!

"leaving out 527 rentals that could weaken your argument is onerous."

Dumb. I could list my co-op for rent even it the Board won't allow it. I can list anything I want.

Get real. Listen to the pros.

Steve--why not start a blog and invite us to comment there?

It all depends on what and where your looking. i suggest you call me for all your real estate needs.If you are buying use a real broker not someone trying to sell you anything, but someone who know's value and can guide you in right direction and protect you from the wrong way.
Vic Parise
917-797-2460

Here's a counter-example to the 12x rule. My flatmate and I are thinking about buying a place. We currently rent for about $2500. We are looking at places in Williamsburg that are about $600K, probably with closing costs thrown in, that could probably rent for about $2500. $2500 x 12 x 12 = $360K, so $600K not a good deal by the 12x rule, but carrying charges are $3241 (with 20% down, 6.2% int for 30 yrs), and the tax deduction should cover the difference in monthly expenses. Doesn't it make sense to buy even with a p/e ratio of 24x?

"Miraculously between the $2,500 I can afford to rent or the $2,333.33 I can afford to buy."

steve, if you could buy something in the same building with the same layout one floor apart for $2,500 (all in) or rent it for $2,500 (assume you will live in the apartment for the foreseeable future). Which would you choose and why?

$17,500 for a lux 2-brdm... wow!

If it is for sale today is is likely overpriced if it has not been reduced since listing.

dj, looking strictly at monthly costs and assuming you plan to stay for more than a few years, buying a $600k place to replace a $2500 rent seems reasonable. Your after-tax monthly costs will be in the same range as your current rent, and you will own your place (which has non-financial benefits) and not have to worry about future rent increases. If you want to try to time the market, you would be better off if prices and rents drop dramatically, but you run the risk of either rents or prices increasing. If you really like the place and want to stay there, the current numbers seem reasonable. You can't go by steve's 12x rule because it doesn't take tax benefits into account, which is why it is silly for him to keep referencing it the way he does.

Don't ask your neighbors apparently: http://blogs.wsj.com/economics/2008/08/06/housing-market-deals-with-reality-gap/

djradon: i would be surprised if you can get a $480k 30yr fixed mortgage on that apt in williamsburg for 6.2%. in your example, you also neglect taxes and common charges as well. i'm not saying i agree with the rule of 12x, but buying at 24x seems aggressive, especially if mortgage rates continue to climb to a more normalized historical level. your math is very similar to that of many people who buy - they figure out how much they can afford on a monthly basis and then back into the price they can pay. but that doesn't make it a good investment - it just makes it a place you can afford for the time being. if financing costs go up, becomes more difficult, local economy softens, etc. then demand decreases and prices come down. and perhaps of all these, the largest driver of demand is the notion that prices in the medium/long term only go up (not sure that has happened fully in nyc yet). when that perception goes, demand retracts rapidly.

put another way, lets say you bought your place today and your place fell a modest 10%. that would in your example be equivalent to getting 2 free years of rent ($2500 x 12 x 2 = $60k = 10% * $600k). if it fell 15%, that's 3 years. with that type of money at stake, i would definitely want to develop a view on whether i could likely get the place cheaper at a later date and not just figure out what i can afford now.

"You can't go by steve's 12x rule because it doesn't take tax benefits into account, which is why it is silly for him to keep referencing it the way he does."

It does, because if you knew anything about economics you would know that the effect of the tax benefit is implicitly taken into account in the price of the house.

Here are historic price-to-rent ratios - which implicitly take into account the tax benefit as that forms part of how the price of a home is determined:

http://money.cnn.com/magazines/fortune/price_rent_ratios/

Click on the P/R ratios tab, and gasp.

What LICC does is invent his own ways of calculating the cost of housing that has no basis in reality or in economic theory. If you want to take into account the tax benefit, you must use the imputed-rent model, which does so explicitly, and it will give you a ratio of about 20x rent.

LICC also ignores the fact that, over time, the mortgage-interest tax deduction goes away, whereas the value of investing in an alternative asset (which he also blithely ignores) accretes over that same time period. LICC also ignores the risk premium involved in owning rather than renting. He also blithely ignores the fact that real-estate is a highly illiquid asset, and when prices fall they do so slowly and stay down for a very long time. He also ignores the very high transaction costs, which must be amortized over the time you spend in the apartment.

He ignores many, many important factors. Like falling prices, which can fall in nominal terms or real terms, and must include the transaction costs. Here's a simple example. Let's say I buy an apartment for $1.1 million. It falls in value by $100,000. I would pay rent of $4,500 for that apartment. That means that, assuming the value falls by $100,000, buy not buying I save myself nearly 2 years' rent in principal.

That doesn't even include the 6% brokerage expense ($60,000), flip tax for co-ops, mortgage tax for condos, mansions tax, prepaid interest (points), attorneys fees, bank fees, etc. The truth of the matter is that if that apartment falls in value by $100,000 - which it might - if I rent instead of buy I will have saved about FOUR YEARS worth of rent in lost principal.

If it falls by $200,000, I would have saved about EIGHT YEARS worth of rent in lost principal.

If it falls by $300,000, I would have saved about TEN YEARS worth of rent in lost principal.

So in an environment of falling prices - which is where we are - unless you have a 10+ year horizon, you can live for FREE just by not buying.

Not including the gains on investing your down payment elsewhere.

So if anybody wants to take LICC's simplistic argument at face value, let them. It is overly simplistic and highly ignorant.

Here is what LICC says to do: Take the full cost of the apartment per month and deduct the mortgage interest from those payments at your highest marginal rate.

You will get the answer that LICC claims you will.

In today's environment, you will also be likely to lose your shirt.

LIC, against my better judgment I'd like to weigh in on the price-to-rent ratio discussion. If you believe that markets are efficient over some period of time, you would expect price-to-rent ratios to come into line over time. If tax laws don't change over time, you would expect the price-to-rent ratio to stay roughly the same. The tax benefit is implicitly included in this ratio, even though it is not in the calculation per se. Only if tax law changes can you argue that the price-to-rent ratio should change over time due to taxes. Please try to consider this, or do some research on it, without remembering that I am supporting Steve's point of view here!

Erratum: $300,000 fall = TWELVE YEARS of free rent!

steve goes on and on, but it is pretty simple to expose the flaws in his analysis.
If rents go up 3%, in 5 years your $4500 is $5200+ per month. If rents go up 5%, it is $5700+. Your not really getting those EIGHT and TEN years worth of savings the he says. Also, his analysis is entirely based on the value of your property declining at the time you sell. If you plan to be there more than a few years, let's say 5, the probability is greater that prices will be flat to up. Could they be down? Sure, but if you want a guarantee of price increases within 5 years of purchase in order to buy, you'll never buy a place. steve has a hard time admitting when he is wrong, and he must have made a decision years ago to rent instead of buy, which was a terrible decision, so he contorts every analysis he can to not admit to himself that he is wrong. He also parrots numbers and analysis without understanding what he is saying. In one sentence he says the 12x implicitly includes the tax benefit in the price of the house, and in the next he says that you should use 20x to take into account the tax benefit.

He also harps on the gains in investing your down payment without talking about the risks of that investment, or on the gains in the value of your property.

TenthStreet - thanks for being respectful while at the same time disagreeing. Way to show everyone how to do it.
As for the ratio, the historical number is based on lots of things that have changed over time. Remember, interest rates have been lower than the historical norm for quite some time now. When rates were 8-10% (or even higher in the early 80s), the ratio would have to be lower. The relative monthly costs to buy were higher. You can't just look at a 12x number and hold to it like it is infallible. You need to look at the actual current situation. When the after-tax monthly cost to own is the same as to rent at 18x or 20x, maybe because interest rates are lower or for some other reason, then you can't keep yelling "12x or it is overpriced and you're an idiot!" That just shows someone who parrots things without understanding them or without looking through to practical application.

But practical application would also factor in a declining market, which you are not.

It would also compare a more likely scenarios...

Not buy and live for eternity vs. rent for eternity...
But buy and live for eternity vs. rent for x years, then buy and live for eternity...

Even if renting costs you $25k more over the next 5 years, if you end up buying in at $250k less, the rent/buy calculation on day one really didn't mean diddly...

LIC, I agree there are other factors besides changing tax law that will change the price to rent ratio. Long-term interest rates are certainly one legitimate reason; short-term interest rates, as we've seen, are not a legitimate reason for the ratio to change. I don't stick strictly to the 12x mantra. However, anyone who believes that current prices in the U.S. or in a given market are stable (and not falling) needs to defend the price-to-rent ratio that is prevailing in that market. So, if the current ratio in the U.S. is 20x (used to be 24x) and from 1984-2002 it was 14.4x, it is important to explain why the difference (note that this period avoids the high-interest-rate regime in the early '80s and the runup in values from 2003+). It would appear to me that Steve's 12x is a better proxy than 20x for what is a stable, long-term ratio. He might be overshooting on the downside but 20x sure seems to overshoot the upside to me.

not sure you saw this post yesterday steve. Question for you:

"Miraculously between the $2,500 I can afford to rent or the $2,333.33 I can afford to buy."

steve, if you could buy something in the same building with the same layout one floor apart for $2,500 (all in) or rent it for $2,500 (assume you will live in the apartment for the foreseeable future). Which would you choose and why?

"If rents go up 3%, in 5 years your $4500 is $5200+ per month. If rents go up 5%, it is $5700+. Your not really getting those EIGHT and TEN years worth of savings the he says."

Actually, if you increase rents by 3% per year it will not have a material effect on how many years' rent you will save. 3% of $4,500 * 12 = $1,620 per year, a far cry from the hundreds of thousands you stand to lose.

"Also, his analysis is entirely based on the value of your property declining at the time you sell."

That's what we're talking about, so of course that's what my analysis is based on. If you think that prices are going up, then you should invest that way.

"If you plan to be there more than a few years, let's say 5, the probability is greater that prices will be flat to up."

There is no such probability.

TenthStreet is correct - there interest rates do affect the ratio, but only in the very short-term. If you want to use specific interest rates, you need to use the imputed rent model, which takes them into account explicitly.

20x is the mean ratio for the imputed rent model, but that model is highly sensitive to a) interest rates; and b) perception of price future price movements. If you believe that prices will fall 5% in a year, the imputed rent model yields 0x, meaning that NO ONE will buy.

"When the after-tax monthly cost to own is the same as to rent at 18x or 20x, maybe because interest rates are lower or for some other reason, then you can't keep yelling "12x or it is overpriced and you're an idiot!""

Because that ratio does not EXPLICITLY include interest rates; it IMPLICITLY includes them in the price of the house. You have invented your own theory and now you expect people to abide by it, and no one will.

Indeed, since banks don't include the "mortgage interest deduction" as part of their affordability criteria of 28% of total income as housing expenses, it's not a practical application in the real world: you can't get financing for an amount that includes the mortgage interest deduction.

"That just shows someone who parrots things without understanding them or without looking through to practical application."

Alas, you are a lost cause.

"if you could buy something in the same building with the same layout one floor apart for $2,500 (all in) or rent it for $2,500 (assume you will live in the apartment for the foreseeable future). Which would you choose and why?"

Juice, if I could do that I would buy to lock in a good rent, but first for the most part in Manhattan it's not possible, and second, you take that quotation entirely out of context: I was discussing how the 28%/40x ratios equate to about the same number, which is the constraint on property price increases.

It seems to me that if you can borrow for a house at 7% (approximate current jumbo rates), which is about 4.25% after-tax (plus or minus at about 40% tax rate), then the rent to buy ratio, ignoring monthly costs on an equivalent basis, would be a maximum of 23.5x (that's 1 divided by the 4.25%)

Now, realistically you need to put some cash down, which should be an at equity rate rather than a debt rate, and in order to borrow you'll need amortization toward principal, which creates an approximate duration (midpoint) of the loan of about 20 years on a 30 year mortgage (pay down less equity in the earlier years than the later years). So pick your required equity return on real estate and factor that in. 7% * some weighted percentage * after tax + equity rate * 1 - some weighted percentage (no tax benefit here) = your new required rate for calculating the multiple (1 divided by the rate) which will be a lower multiple than the 23.5x above.

A 12x multiple would indicate 1 / 12 = 8.33% return comprised of an equity percentage and an after-tax debt percentage.

Also, it would be necessary when making these comparison calculations to adjust for the monthly costs of the owner imputed into the rent, with special treatment for two particular components - first being the real estate taxes, on which the owner will have a deduction, and second being for co-op the interest and principal included in the maintenance. So whatever multiple you are working with, whether 12x or 23.5x or anywhere in between, those multiples would have to be applied to numbers exclusive of a built-in mortgage and the real estate taxes. If the 12x were an average across all areas, then obviously it would be, say 11.5x in some areas where the real estate taxes on the property were lower and say 12.5x in some areas where the real estate taxes on the property were lower. - but you should get my point.

Further on the mortgage issue, when looking at a co-op, you should consider your purchase price as the price you are paying to the owner, plus the apartment's share of the mortgage on the property, plus the apartment's share of any determined reserve fund shortfall. So if you are buying a co-op for $250K, and the building has a $2MM mortgage for which your unit has a 2% share, effectively your purchase price is $290K.

And to dispel the "mortgage interest tax credit":

http://www.c-c-d.org/task_forces/housing/od-dec98.htm

"TOTAL HOUSING EXPENSE (does not include credit for mortgage interest deduction)"

"PITI: Principal-Interest-Taxes-Insurance is the total housing expense on a monthly basis. Also includes homeowners association fees, and monthly mortgage insurance if applicable."

http://ficoforums.myfico.com/fico/board/print?board.id=loans&message.id=4618&format=one

steve, except for one stupid sentence toward the end, I will give you credit for finally writing a comment that explained your analysis without insulting, rude, arrogant or smug remarks. Keep this up and maybe we can have some enjoyable discussions in the future.

whatever multiple you are working with, whether 12x or 23.5x or anywhere in between, those multiples would have to be applied to numbers exclusive of the monthly costs, with adjustment to the monthly costs based on the built-in mortgage (e.g. to the co-op) and the real estate taxes.

itseemstome, I don't understand what you mean in your second post.

In your first post: those components are taken into account using the imputed rent model, and you do wind up with a ratio of about 20x, mostly depending on expectations for future price increases.

12x does not include those components explicitly.

Here we go again with the corrected sentence:

It seems to me that if you can borrow for a house at 7% (approximate current jumbo rates), which is about 4.25% after-tax (plus or minus at about 40% tax rate), then the rent to buy ratio, ignoring monthly costs on an equivalent basis, would be a maximum of 23.5x (that's 1 divided by the 4.25%)

Now, realistically you need to put some cash down, which should be an at equity rate rather than a debt rate, and in order to borrow you'll need amortization toward principal, which creates an approximate duration (midpoint) of the loan of about 20 years on a 30 year mortgage (pay down less equity in the earlier years than the later years). So pick your required equity return on real estate and factor that in. 7% * some weighted percentage * after tax + equity rate * 1 - some weighted percentage (no tax benefit here) = your new required rate for calculating the multiple (1 divided by the rate) which will be a lower multiple than the 23.5x above.

A 12x multiple would indicate 1 / 12 = 8.33% return comprised of an equity percentage and an after-tax debt percentage.

Also, it would be necessary when making these comparison calculations to adjust for the monthly costs of the owner imputed into the rent, with special treatment for two particular components - first being the real estate taxes, on which the owner will have a deduction, and second being for co-op the interest and principal included in the maintenance. So whatever multiple you are working with, whether 12x or 23.5x or anywhere in between, those multiples would have to be applied to numbers exclusive of the monthly costs, with adjustment to the monthly costs based on the built-in mortgage (e.g. to the co-op) and the real estate taxes. If the 12x were an average across all areas, then obviously it would be, say 11.5x in some areas where the real estate taxes on the property were lower and say 12.5x in some areas where the real estate taxes on the property were lower. - but you should get my point.

Further on the mortgage issue, when looking at a co-op, you should consider your purchase price as the price you are paying to the owner, plus the apartment's share of the mortgage on the property, plus the apartment's share of any determined reserve fund shortfall. So if you are buying a co-op for $250K, and the building has a $2MM mortgage for which your unit has a 2% share, effectively your purchase price is $290K.

If you are looking at a condominium versus a rental apartment unit, and using someone's $4500 rental, if you assume that monthly maintenance expenses on the unit are $500, and the real estate taxes (no abatements etc) are $500 net of taxes, the apartment has a net revenue to the apartment owner of $3500. So applying a 12x multiple, if that is the correct multiple, is an equivalent value of $500K, and using a 20x multiple you are getting to $850K, and a 23.5x multiple (7% borrowing rates) just shy of $1 million.

The 12x and 20x ratios are measured calculating different things. Therefore, your argument is false.

Great analysis itseemstome, well done. In your hypothetical, a 12x multiple appears much too low. The after-tax monthly cost of a $700k mortgage plus common charges and taxes would be at the $4500 range.

I run the numbers....

"If the 12x were an average across all areas, then obviously it would be, say 11.5x in some areas where the real estate taxes on the property were lower and say 12.5x in some areas where the real estate taxes on the property were lower. - but you should get my point."

You miss the entire point. The 12x ratio implicitly takes taxes into account, so you're calculating them twice.

As with the "tax benefit."

steve, the ratio uses the price amount, and the rent amount. It does not discount the actual cost of the home by the savings from the tax benefits. You run the ratio at 12x or at 20x and you get different numbers. Basically, you are saying that 20x is the number to use.

Again, well done itseemstome.

"Juice, if I could do that I would buy to lock in a good rent, but first for the most part in Manhattan it's not possible, and second, you take that quotation entirely out of context: I was discussing how the 28%/40x ratios equate to about the same number, which is the constraint on property price increases."

steve, thanks. I wasn't trying to take you out of context, it was a serious question. So you would purchase if an apartment was $2500 and renting was $2500. ok good, next question same scenario, $2500 to buy or $2500 to rent. What would be a better deal for you, if you were able to buy at $2500/mo with a 6% interest rate or $2500/mo with an 8% interest rate?

"It does not discount the actual cost of the home by the savings from the tax benefits."

That is included in the price of the home. The concept is called the "discount," if you understand how it works. Just like an apartment with high maintenance costs less than an identical one with low maintenance, a property with high taxes costs more than one with low taxes. And the taxes are the net taxes - you lower the tax rate, the price goes up.

Or do you deny that?

"You run the ratio at 12x or at 20x and you get different numbers. Basically, you are saying that 20x is the number to use."

What? I'm saying that if you use the imputed rent model you will (usually, not always) get a higher number than 12x. That's because it measures things explicitly, rather than implicitly.

"What would be a better deal for you, if you were able to buy at $2500/mo with a 6% interest rate or $2500/mo with an 8% interest rate?"

That's a dumb question - it makes no difference. The price of an apartment will fluctuate depending on the interest rate, so the net output would be the same (in the medium-term).

Because price is a function of income.

Just answer the question steve. What is a better deal for you in that situation?

JuiceMan, I did answer the question. The interest rate makes no difference in the medium- to long-term, because the price of the property will rise or fall to compensate, so that it becomes affordable.

Perhaps you could explain which you think is the better deal, because as I see it, you have a $2,500 PITI and $2,500 rent for a virtually identical apartment. What difference does the interest rate make?

Now - what DOES make a difference is extreme interest rates and expectations for future interest rates. For example, if interest rates are 15% and you expect them to fall to 5% in 2 years - a possible scenario - then it would behoove you to buy at the depressed price, pay 15% interest, then refinance, as long as the rent = PITI.

Unless you can explain it differently so that I can understand it, in which case I might agree with you. It's happened before.

Thanks for your input re:
"If the 12x were an average across all areas, then obviously it would be, say 11.5x in some areas where the real estate taxes on the property were lower and say 12.5x in some areas where the real estate taxes on the property were lower. - but you should get my point."

You miss the entire point. The 12x ratio implicitly takes taxes into account, so you're calculating them twice.

As with the "tax benefit."

So just taking a bit of math in an example shows how my statement is correct. Situation 1 is where a property is worth $300,000, and has annual real estate taxes of $10,000. Situation 2 is where a property is worth $300,000, and has annual real estate taxes of $2,000. In both cases, the property was recently purchased and sold for $300,000. If we take the 12x ratio on annual rent, or 144x on monthly rent, the $300,000 dwelling would be available for rental at $2083 per month or $25,000 per year. Rental income minus real estate taxes (ignore deductability of real estate taxes) available to the owner in scenario 1 is $25,000 minus $10,000 or $15,000. In scenario 2, it is $25,000 minus $2,000 or $23,000. The adjusted rent to own multiple, subtracting taxes, is in scenario 1 is 20x and 13x in scenario 2. Clearly it would be cleaner to have an equivalent adjusted rent multiple (whatever that is in this situation somewhere between 13x and 20x), but what this shows is that if the 12x of unadjusted rent to own multiple is based on historical averages across all markets, that since a 20x vs 13x adjusted multiple wouldn't be at all logical, the 12x unadjusted is actually likely to be different across markets.

In the scenario 1 market, it is likely that the actual unadjusted ratio would be lower than 12x and in scenario 2 the actual unadjusted ratio would be greater than 12x, and together they would average 12x.

To finish the example tangibly, again both houses are worth $300,000 and just sold for that price. In situation 1 and where the taxes are higher, you'd expect the montly rent to be higher to account for equivalent returns to the owner and then the higher real estate taxes - therefore a lower multiple. In situation 2 where the taxes are lower, you'd expect the monthly rent to be lower than situation 1 because taxes (cost to the owner) are lower - therefore a higher multiple.

Thanks.

To finish the example tangibly, again both houses are worth $300,000 and just sold for that price. In situation 1 and where the taxes are higher, you'd expect the montly rent to be higher to account for equivalent returns to the owner and then the higher real estate taxes - therefore a lower multiple. In situation 2 where the taxes are lower, you'd expect the monthly rent to be lower than situation 1 because taxes (cost to the owner) are lower - therefore a higher multiple.

To finish actually tangibly!, if total rent for the two houses stayed at $25,000 + $25,000 = $50,000, and total rent net to the owners subtracting the two real estate taxes was $15,000 + $23,000 = $38,000, you'd likely assuming equilibrium have $38,000 / 2 in annual adjusted rent = $19,000 per property. So in scenario 1, the owner should charge the $19,000 plus the $10,000 in taxes or $29,000 per year or $2417 per month, and in scenario 2 the owner should charge the $19,000 plus $2,000 in taxes or $21,000 per year or $1750 per month. The unadjusted rent to own multiples on these $300,000 properties are actually 10.3x in scenario 1 and 14.3x in scenario 2.

Thanks again

Interesting; I guess a flat 12x is a bit too simple to be true

"...Sure malraux, I'll show you why you're wrong. Here are the 10 most expensive 2-bedroom apartments currently listed in Manhattan on nybits...which one do you see costs $17,500 per month?..."

Just go to www.streeteasy.com/nyc/building/15-central-park-west-new_york weasel-boy, and see nine apartments (all 2 bedrooms except for one) currently on the market at $15,000(+)/month. In that building alone. And for those 9 or so units that are left on the market, I can tell you with authority that over five times that amount of units have been already rented out.

"...The only apartments listed on this website for rent at $15,000+ per month are idiots like malraux who drank the real-estate Kool-Aid and are trying to recover their costs..."

Perhaps, except my place at 15 CPW is rented out for a three year contract already (well in to the $20K's) - oh, and did I forget to mention that on average, units at 15 CPW have appreciated 92% since one year ago (according to our friends at streeteasy.com)? And let me remind you that after my renter in that building has paid my mortgage and RE taxes every month, he's also stuffing positive cash flow in my pocket as well.

Is this normal or indicative of the market as a whole? Absolutely, positively not - it is most assuredly an anomaly. But was it an anomaly that I was able to spot as a real estate investor with 20+ years experience in Manhattan residential market? You betcha. It was clear that the market for this specific building would have its own gravity and logic. And that's why I'm successful at what I do - I don't use crass market generalization like 12x, or 15x, or x(x) to determine whether a residential property is a good or bad investment in a given market scenario - there are just to many intangibles unique to each specific situation. Had I run the numbers as strictly as you suggest, it would not have made sense according to your formula. There was a certain intuitve leap of faith that was taken based on my track record that told me that this specific building, and not another equivalently priced building (like say, the Plaza) was a slam dunk, assuming a market correction to eventually be on the horizon. And my expertise has paid out - handsomely.

At the end of the day, you can spout endless theories about the supposedly incontrovertible "hard" math involved - you seem to really enjoy that - you're definitely a real 'quant' kind of guy. And of course, hard math is not to be ignored! But there is much, much more to investing in Manhattan residential real estate. That's why this supposedly 'bad math' deal (according to you) has gone up in value well over 100% in one year, and is locked in to a very lucrative long term rental with positive cash flow, all your fulminations about nybits.com and drinking kool-aid aside.

So I have a property. I have it priced above this 12x multiple that someone here has proven is such a broad-brush statement as to make it useless. But anyway, it is above 12x. It is above 24x. Woah is me. Someone buys the property from me....

explain how it was overpriced?

malraux, you're too easy.

First, I think you need to apologize to all of us - weasel boy - for your ridiculous comment about the applicability of Case-Shiller index to "Prime Manhattan" Real Estate. Still waiting on that one....

Then: weasel-boy, and see nine apartments (all 2 bedrooms except for one) currently on the market at $15,000(+)/month."

First, what building? Second, those are asking rents. Third, you can ask for anything you want. Market-rate rental buildings know what market rental rates are.

"In that building alone."

"And for those 9 or so units that are left on the market, I can tell you with authority that over five times that amount of units have been already rented out."

"With authority" - just like the Case-Shiller index?

"...The only apartments listed on this website for rent at $15,000+ per month are idiots like malraux who drank the real-estate Kool-Aid and are trying to recover their costs..."

Perhaps, except my place at 15 CPW is rented out for a three year contract already (well in to the $20K's)"

I truly believe that you own an apartment at 15 CPW. Truly, truly believe. And that petrfitz lives next door to Celine Dion.

"oh, and did I forget to mention that on average, units at 15 CPW have appreciated 92% since one year ago (according to our friends at streeteasy.com)?"

Typical, common, right?

"And let me remind you that after my renter in that building has paid my mortgage and RE taxes every month, he's also stuffing positive cash flow in my pocket as well."

Yup.

"you're definitely a real 'quant' kind of guy."

Actually, quite the opposite.

AnneC - "Woe is me." We're not talking horses.

Or maybe we are: "But anyway, it is above 12x. It is above 24x."

Why would anybody want to buy at that ridiculous price? You sound like the person in Miami trying to sell an apartment at $849k when the one 2 floors above it is asking $697k. Eventually, as inventory soars (or perhaps, given your spelling abilities, I should say "sores") you will see.

weaselboy, you're an idiot.

"First, what building?"

15 CPW

"Second, those are asking rents."

Yes, and as I said, over 5X that many units in that building alone have rented out on average for about that much calculated on a psf. Most of the units left for rent are lines that do not have a direct CPW view, which at the end of the day is what the building is about and what renters will pay the big bucks for. Renting in that building and looking out over the back (Broadway) side ain't gonna cut it at those asking prices. It was clear when you bought into the building - it was some sort of view of CPW, or don't bother at all (in terms of an investment strategy).

"Third, you can ask for anything you want."

Yeah, just like you apply whatever quant theories you want. You can wag your finger and say 'oh, it's ridiculously overpriced' at anything you want. You may very well be right that it's overpriced - but that fact, and that fact alone, has absolutely no bearing on whether a specific unit will rent (or sell) for a specific asking amount. Your broad generalities simply don't apply to every specific condition.

"Market-rate rental buildings know what market rental rates are."

Yes, and that's my point. "Market rate" doesn't reflect all aspects of a market, nor is it indicative in any way of market anonmalies that a seasoned real etate investment pro opportunistically isolates and acts upon. Who wants to invest in in things that are just 'maket-rate?'

"With authority."

I have seen the rundown of owner occupied vs. owner rented units.

"I truly believe that you own an apartment at 15 CPW. Truly, truly believe. And that petrfitz lives next door to Celine Dion."

Yeah, and we all believe your 60% annual returns. Doesn't matter. It was probably the best real estate deal I'll ever make. I mean, granted, I was prepared with a lot of previous experience, but luck and timing were definitely a factor as well, as they are in any investment one makes.

"Typical, common, right?"

I direct you to my quote above 'Is this normal or indicative of the market as a whole? Absolutely, positively not - it is most assuredly an anomaly.' So why would you make such a idiotic observation?

malraux, the only way steve will understand what you are saying is if you get the Quinnipiac University Polling Institute do a survey on 15 CPW owners or have a couple professors and a Fed guy write a white paper about Albany and then apply the results to 15 CPW.

"And that petrfitz lives next door to Celine Dion."

Why on Earth would anyone lie about living next to Celine Dion? If you are going to lie about something like that, wouldn't you want to go bigger? Maybe like saying you lived next to David Hasselhoff? (I've included a picture for steve)

http://irestidelcarlino.files.wordpress.com/2006/12/david-hasselhoff-07.jpg

JuiceMan, you should warn people not to be eating when they click on that link.

oy vey....

has anyone figured out that EddieWilson and Stevejhx are the identical person?

Same positions
Same style of posting a negative article as worthy of its own discussion topic
Same argument style
Same style of rebuttal, interspersing the original quote and his response
Same claim to have worked at an investment bank, but seemingly not in the investment banking group itself
Same language style and pedantry related to language
Same self-corrections of their own posting
Same imperfect ability to do math
Same level of anger
Same reference to "they" and "them" as out to get people who don't think real estate is going up

what else is the same ... anyone care to point it out?

Esuecho has to be LICC. He's now posted the same exact nonsense post on 10 different threads. Sounds just like LICC...

Hey Steve, if you are so smart, how do you explain Japan at a 26 year low? What is the mean that it is reverting to?

Hey EddieWilson, sorry you don't like a strong woman. Bet you are into S&M. Oh, are you nyc10022?

Is the property in Manhattan? It's overpriced.

Steve, nice way to put it:

"housing is a leveraged asset which produces an expense and financial leverage produces income

What is the argument for using 12x?