Strassia, your posts are very insightful. You have a gift for stating your points plainly and simply.
The response can get dumber. Who would have thought it possible?
On the renting v.buying discussion, I think everyone is right, it’s just that the time issue is not being discussed openly. It’s true that you would initially pay less to rent a particular piece of property than you would to finance it. But rent goes up every year while principal and interest payments don’t. So if one guy buys a house with a 30-year mortgage and rents it to another guy for each of those 30 years,the renter typically ends up paying more over the life of the property than does the purchaser, and the excess is the purchaser’s return on investment. If the buyer sells the place during that 30 years, the price will typically be set so that the same process occurs (i.e., rent is less than the cost to finance for the first few years), which is why the renter perpetually can rent for that year for less than he could buy for that year). Stated another way, a person that buys a place to live (instead of to rent out) pays more in the first few years than he would if he rented because he gets to pay less thereafter.
Gonzomax, we’re still waiting to find out from you whether the plane on the treadmill takes off. Thx.
I tried that explanation in post 52. Amazingly, it didn’t help.
His point wasn’t just that it’s a losing game. He was claiming that somehow it’s unfair and that you have zero equity after 5 years (both of which are untrue).
The bank can’t pro-rate your interest evenly over 30 years because you and the bank both know that your sorry ass isn’t staying in that house 30 years. If they did pro-rate it and you sell after 5 years, you would have gotten away with an effective interest rate of 0.07% (pretty damned good). Since the bank isn’t interested in going broke, they take your lying self at your word and amortize it as if you will pay it over 30 years.
If you don’t like that, then you should get a 5-year mortgage. You’re guaranteed to have 100% equity after 5 years. But nobody wants to live within their means, they want to play with big money that isn’t theirs. If you do that and get screwed, nobody’s fault but yours.
I don’t know what “time issue” you’re talking about. Rents are determined by the marketplace via supply and demand. Rental rates as a national aggregate increase at the same rate as inflation (as it must, or eventually everyone will be devoting 100% of their incomes to rent alone), but there are certainly good and bad rental markets in the same way there are good and bad stocks, eg, shares in Apple vs shares in GM, compared to an apartment in Detroit vs an apartment in San Diego. In considering a capital investment such as a house, one considers the current market rents, and invests when the current market rents coupled with conditions in the capital market support a healthy return on capital to compensate for the risks that you are buying the next GM instead of the next Apple, PLUS the excessive duration of highly leveraged real estate. Keep in mind that the United States is one of the very few developed countries in which consumers can secure fixed mortgage rates for the entire amortization period - through government subsidies in the form of Fannie Mae and Freddie Mac, which untill recently were simply taken for granted as permanent fixtures. In a rational market, rents MUST exceed the costs of capital or your economy would collapse.
Oh…wait. I see what you did there. 
Auto loans are even worse! If you take out a $20k loan for 5 years at 10% interest, after a year you’ve paid $5100, but you still owe just under $17k on the loan. And to make it worse, your car is probably worth less than $14k! I wonder how that doesn’t make gonzomax’s head asplode.
Compared to that racket, mortgage companies are charitable organizations.
Oh well.
gonzomax - you’re still active in this thread. do you understand that splitting the capital and interest repayments into identical slices across the whole term means that, in the first 5 years of the mortgage, you’d be getting a fantastically low interest rate?
Read his citation of this screw-the-little-guy phenomenon and reread post #96. It’s clear that he doesn’t know what an interest rate is, so he naturally doesn’t understand how to calculate one.
Besides, he’s trolling now anyway, since all he’ll say is how dumb the rest of us are for not understanding his mystery math.
Lets put it in numbers. Say I take out a 30 year fixed mortgage on a house and my total outlay is 850 a month for my mortgage and insurance. My rents coming in is only 750 a month today. Why would this make sense? For two reasons: a) My principle goes down each month by over 100 dollars, therefore I am actually making a profit (you do not consider the amount that goes into principle as a loss because you will get that money back when you sell). b) In the long term, even if you consider that 100 difference a loss, it is a short term loss. If my rent goes up $50 a month per year more than my costs(mortgage payment is fixed, so only insurance and maintenance go up) , then I will break even in 2 years, and be positive cash flow in three. After that, my expenses(insurance and maintenance) go up much slower than my income. I should make back all my losses within 10 years and after that it is an income stream.
Thank you, it is good to hear.
That was the whole point I was trying to make. Buying only makes sense if you are going to hold onto the house for a long enough period that inflation pushes rents above your mortgage. Anything less than 7 years should not make profit unless housing prices and rents are going up significantly higher than wages.
For most people even a 10 year (fixed rate) interest only loan works out in their favor just do to inflation. Think of this, which would be more affordable: A 700,000 loan amortized over 30 years, or a 400,000 loan amortized over 20 years? I just ran the numbers and at 5%, the second loan would be cheaper. The house I paid 775,000 last sold in 2000 for 400,000 (I know that was a non-typical period, but you save money if the house appreciated by 3% or more).
Jonathan
I would think that you would pay a premium for renting as well:
-
The owner of the property is not going to rent at a loss. It would be in his interests to sell the property vs. renting it to someone and lose money.
-
When you rent, you aren’t “throwing money away” like the common thought goes. You are paying for a service. You are paying for portability. If you want to move, off you go; no worries about putting the house on the market, hiring a realtor, etc.
-
When you flush the toilet and notice a streaming fountain of raw shit cascading out of the master bathroom, and you rent, you dial 1-800-LANDLORD and then go to a bar. When you are a homeowner, you shell out thousands of dollars to repair your septic system which will never work right again.
I’m not saying that you shouldn’t experience the joys of homeownership, but when you are single and/or young, or have another lifestyle situation that makes settle down not feasible for you, there isn’t a thing wrong with renting…
Of course not. But originally, we were discussing rending a property for more than the cost of the mortgage
When you pay your mortgage, you get in exchange two things : the right to live in the house and equity. When I rent it from you, I get only the first one. You can’t expect me to pay more for one thing than you pay for both.
If you’re buying a ham sandwich, you can’t remove and eat the ham, and then expect to sell me the bread for more than the price you paid for the sandwich. What I’ll accept to pay will be the price of the bread plus something to compensate you for the trouble of bringing it to me. Except if there’s a famine in the area.
Similarly, a “fair price” for renting a property would cover the interests you pay plus something for your troubles (you’ve immobilized your capital in a house, for instance). You’re not breaking even, in this case. You’re making money. Even if the rent I pay is less than your mortgage. Because your mortgage payments include the equity, and you get to keep that. I don’t benefit from it as a renter, and there’s no reason I should, or would, pay for it.
In the same way ** Gonzomax ** apparently forgets to notice that he’s getting something (the house he lives in) besides the equity when he pays his mortgage, some landowners who insist that the rent should legitimately be at least as high as the mortgage forget to notice that they’re getting something (the equity) besides the rent.
It is obvious for instance in the case of two persons buying identical houses, one with a 30 years mortgage, and the other making large payments on a short-term mortgage. Even though the second pays each month twice as much as the first, he’s not going to rent the same house for twice as much.
Of course, in practice, most of this is irrelevant. The rent will be whatever the market will bear. You might be able to rent it for more than you pay for the mortgage because people are desperate to find a place to live in in the area, or the return on your investment might be lower than the interest rates. Especially since, contrarily to ham sandwiches, you can’t exactly bring your house to a place where people are starving.
Why?That is off subject,irrelevant and I and I see no reason to answer it. You may wait a long time.
Indeed. And the cost of the capital is the interests you pay on your loan, not the total payment you make.
But he is not losing money, and he does get a premium for renting (or at least, normally, he should). It’s simply that the mortgage payment has no relevance to the rent (he’s not going to rent the house for $10/year once he’s finished paying his mortgage, because the house doesn’t cost him anything anymore, is he?).
It’s a common fallacy that the rent should pay for the mortgage. It even doesn’t make sense because for the same property, rented for the same price, you can be making vastly different payments depending on the duration of your mortgage.
I believe it’s once again one of those myths (house values will always rise, renting is throwing money out of the window, etc…) that support the misguided idea that you’ll always be better off by making the wise choice of being a house owner. The magical renter who will pay for your mortgage doesn’t exist anymore than the magical guaranteed price rise that will allow you to repay your loan. Well…they might in some situations, but you certainly can’t count on that.
Are we going to have wait a long time for you to answer the questions that are on subject and relevant?
All of this discussion brings me back to my original point: In a rational market, without exceptional distortions, a house (to live in or to rent out) is a poor short term investment. Long term it may make sense, but short term you are better off renting or putting you money in the bank.
Jonathan
First, as I’ve already indicated, a “30 year fixed mortgage” simply does not exist in most countries. It has existed in the United States since the Great Depression due to massive US government intervention in the mortgage industry, namely, through the ability to make a secondary market for mortgage backed securities via Fannie Mae and Freddie Mac. This means that A) Your experience may not be relevant to those outside the US, and B) It is not certain that this policy may continue in this day and age.
Secondly, I already outlined how the numbers work in my link. As you’ve already realized, in calculating a return on a capital project, repayment of mortgage principle is obviously not an expense in the typical sense of the word. You don’t provide nearly enough numbers to come to any meaningful conclusion in your particular case, but basically what you are saying is that your asset currently generates a return of zero, assuming you’ve taken into account the opportunity cost of your downpayment, correctly calculated the present value of the opportunity cost of your principle, and many other things that even very experienced property investors miss and/or underestimate, and you have taken on liability with many times the leverage and the ensuing interest rate sensitivity speculating that in the future, the property’s income generating capacity will increase. Are your returns sufficient to overcome your cost of capital, and still be sufficient to compensate you for your risk? I don’t know and I’m not asking, I’m just saying that a rational investor would generally make sure that he was.
You are both misunderstanding me. You as a real estate investor have no control over rents, beyond what can be secured for the duration of a lease minus default risk. You collect the best rents the market will bear and that’s that. You can’t even predict what rents will be in the future, any more than you can time the stock market. The only thing you DO have control over, and indeed what I am discussing here, is the pricing of the asset. Again, a rational investor would not pay a price for an asset without adequate compensation for his risk. If the asset price is inflated to the extent that the current earnings and reasonable future earnings potential do not begin to cover the risks (i.e. where it is cheaper to rent the house than to buy it), the the asset is overvalued.
As an aside, I forgot this bit…
I won’t explain what financing is since you probably already know, however, The cost of leasing a car is basically a fixed amount per month based on the lessor’s estimation of future depreciation + a financing charge on the cost of the entire car, combined with a ** put option** using the residual value as the strike price. I have said, in past car lease vs buy threads, that leasing is a MUCH better deal for the lessee. The lessee actually always pays a little more interest on his deal than he would if he purchases the car, although this is beneficial come tax time, but gets more than enough in return in the intrinsic value of the put option.
For example, suppose 2 people both get cars, drive them for one year and returns them for new cars. One leases and one buys, both at the same price. At the end of the lease, one of three scenarios will occur:
A) The lessor’s depreciation tables overestimate the residual value, the lessee and the buyer both have cars that are worth about the same (some amount less than the residual). The Lessee can simply return the car and leases a new one, paying only the agreed upon amount for depreciation while the buyer takes a relative loss selling his car. Advantage: Lessor.
B) The Lessor’s depreciation tables underestimate the residual value. In this case, both the lessee and the buyer will sell their cars privately. The lessee would have paid a bit more in terms of interest.
In reality, scenario A is far more likely than scenario B, as 1) car makers often subsidize leases by overestimating the residual value in order to move units (a practice called subventing) and often will also offer 0% lease financing, and2) it is much more likely that some previously unknown fault will dramatically drive down the resale value of a car, as oppose to…the resale value of a car unexpectedly going way up, I guess - I can’t even think of a plausible reason why that would happen to a non-rare/exotic car. But even then, leasing is still a better deal.
Of course, you can’t get leases any more, unless you wanted to pay 12% interest, because the car makers, especially the Big 3, drove themselves to bankruptcy partly because of their overly generous lease policies. Oh well, fun while it lasted.
I have a feeling that we are getting more into the nitty gritty calculations of costs of renting vis a vis buying, which isn’t my intent.
Anyway, in short:
-
Generally rational investors invest in enterprises that have positive returns, in addition to a risk premium. That means buying should ALWAYS be cheaper than renting, since the renter is paying the risk premium.
-
When the price of an asset grows to the point where the returns no longer support the price, then the asset is overvalues.
-
When asset prices have been growing out of proportion to their earnings for such a long time that it somehow becomes common wisdom that earnings are no longer important, and that only future appreciation of the “greater fool” variety is needed (i.e. cheaper to rent a house than to buy it but you should buy it anyway because EQUITY LOLOLOLOL, dot-com startups worth hundreds of millions with no revenue because INTERNETZ IS THE FUTURE LOLOLOL), it is likely that you are in the midst of a speculative asset bubble.
-
The price of residential real estate in the long term tends to track inflation.