I think this underemphasizes the transaction costs and costs of ownership. In broad terms, property tax, insurance, and repairs are all "rent" and money that you will never see again [repairs can admittedly be in the vein of capital improvements that can be recaptured, depending on specifics]. Likewise, mortgage interest is "rent" although you get to pay it on a pre-tax basis. Note that for the first several years the vast vast majority of your mortgage payment is interest. Of your mortgage payments from years 1-5, some 70%+ are going to "rent" that you will never see again...
The real kicker is the transaction costs when you sell. Standard commissions are 4-6% of the sales price, and that is on the margin and therefore comes *directly out of your equity.*
Yes, if you assume that your housing will substantially appreciate, it makes sense to buy. As a general matter, one wants to own assets that are appreciating in value. But don't forget opportunity costs: what would you have otherwise earned on that $160k you put down on the $800k house?
But if you make conservative assumptions about appreciation, the timeline for breaking even is often 5-7 years. And that doesn't make sense for a lot of people. The timeline would be even longer if not for the distortionary home interest deduction.
Arnold, how many of your readers are below 18 years old? If not many, I would rewrite your post to educate parents on presenting their children with such options.
Wonderful and accessable introduction to the economics of renting and buying.
However: "If you are making a long-term commitment to live in a closed-access city, then you probably will be better off buying than renting." Price to rent yields are much lower in closed access cities than in open access ones (equivalently, rental yields are much lower). This sends the opposite signal, than renting is a better deal in expensive cities.
The median Manhattan apartment costs a million and has about $2,000 a month maintenance (I think this includes taxes) and is about 750sf and typical 2 bedrooms.That's for roughly $5,000 a month for rent. The comparable average rent on a two bedroom apartment in Manhattan is $3900 a month. So I instead of expecting 2% appreciation a year on the million dollar apartment you could save $13k a year. And if you wanted to, you could lever up the investment in the stock market.
And, for what it is worth, I think the 3.5% is too low for the blended cost of capital for a home. Given purchasing and selling costs, and equity like returns on the down payment, it seems like it could be substantially higher, especially if you don't itemize.
Does this analysis account for the effect of rent control in closed access cities? A renter might believe that if they get a rent controlled apartment, they will do ok over time, and that they would rather live a more constrained lifestyle in a closed access city than a less constrained one in an open access city.
As an extreme example, one of my son's classmates in San Francisco is growing up, with his younger brother, in a *very* small (probably at most 600 sq ft) apartment in a well-located older building. His parents got the apartment many years ago before they had kids, and rent control now makes it a great deal. I don't know how much longer the four of them can persist in this situation, but I am pretty sure their earning potential would let them buy a house in the East Bay suburbs or in an open access city, and they value the San Francisco lifestyle, warts and all, too much to make that choice.
This article hit home. I bought my first home in February at the age of 36 for $860,000 in Los Angeles. I regret doing the "responsible thing" by paying off all my student loans, maximizing my 401K and HSA contributions, and diligently saving for a 20% downpayment. Humble midwestern values are not rewarded or valued in this city. My peers who leveraged themselves to the hilt or bought with the help of their parents years ago are sitting on very healthy six-figure gains and are either trading up for homes in neighborhoods with better schools and shorter commutes.
I think Arnold misses a very important factor in this analysis, down payment.
In expensive "closed access" cities, rent is already ~half of income. In his example, even at 10% down payment, ~2.5 years is needed just for the down payment while saving the non-rent 50% of their income (actually longer due to additional costs of purchase).
What is the actual savings rate for most Americans? Certainly not 50%. Closer to 15% (generously). At 15% saved it is almost 9 years for a down payment. And during that 9 years their savings have to keep up with appreciation to not fall further behind. If, as Arnold suggests, appreciation is large due to inflation, that 9 year number will increase.
Young people without very high incomes or wealthy and generous family simply haven't had enough time to be in a position to buy a home in these places.
I'm 'familiar', personally, with this choice for NYC, and there's two other costs that I think potential buyers might also want to consider:
- Childcare
- (Potential) divorce
Even _part-time_ childcare, i.e. NOT covering a typical work day, or NOT covering an entire typical work week, or (also commonly), NOT covering either, is probably more expensive than the rent on (another) apartment. The 'obvious' workaround is for the lower-income parent to stay home with any kids. The less obvious (to me) workaround is to hire a 'nanny' 'under the table'.
Divorce is, at least statistically, extremely likely.
What about the specific risk of holding a specific real estate property? Specific bad things can happen to your property, which don't affect the macro residential market. The regime could build a housing project in your neighborhood and destroy the property value, or there could be an election-year racial tension campaign in your town, look what's happened to Minneapolis. Not theoretical and not forgotten history.
Owning property in a declining civilization is a risky proposition, and by renting, you pay someone else to take that risk. Do you buy in Rome, in Ravenna or in Constantinople? Hard to tell which is which.
I think this underemphasizes the transaction costs and costs of ownership. In broad terms, property tax, insurance, and repairs are all "rent" and money that you will never see again [repairs can admittedly be in the vein of capital improvements that can be recaptured, depending on specifics]. Likewise, mortgage interest is "rent" although you get to pay it on a pre-tax basis. Note that for the first several years the vast vast majority of your mortgage payment is interest. Of your mortgage payments from years 1-5, some 70%+ are going to "rent" that you will never see again...
The real kicker is the transaction costs when you sell. Standard commissions are 4-6% of the sales price, and that is on the margin and therefore comes *directly out of your equity.*
Yes, if you assume that your housing will substantially appreciate, it makes sense to buy. As a general matter, one wants to own assets that are appreciating in value. But don't forget opportunity costs: what would you have otherwise earned on that $160k you put down on the $800k house?
But if you make conservative assumptions about appreciation, the timeline for breaking even is often 5-7 years. And that doesn't make sense for a lot of people. The timeline would be even longer if not for the distortionary home interest deduction.
Arnold, how many of your readers are below 18 years old? If not many, I would rewrite your post to educate parents on presenting their children with such options.
Wonderful and accessable introduction to the economics of renting and buying.
However: "If you are making a long-term commitment to live in a closed-access city, then you probably will be better off buying than renting." Price to rent yields are much lower in closed access cities than in open access ones (equivalently, rental yields are much lower). This sends the opposite signal, than renting is a better deal in expensive cities.
The median Manhattan apartment costs a million and has about $2,000 a month maintenance (I think this includes taxes) and is about 750sf and typical 2 bedrooms.That's for roughly $5,000 a month for rent. The comparable average rent on a two bedroom apartment in Manhattan is $3900 a month. So I instead of expecting 2% appreciation a year on the million dollar apartment you could save $13k a year. And if you wanted to, you could lever up the investment in the stock market.
And, for what it is worth, I think the 3.5% is too low for the blended cost of capital for a home. Given purchasing and selling costs, and equity like returns on the down payment, it seems like it could be substantially higher, especially if you don't itemize.
Does this analysis account for the effect of rent control in closed access cities? A renter might believe that if they get a rent controlled apartment, they will do ok over time, and that they would rather live a more constrained lifestyle in a closed access city than a less constrained one in an open access city.
As an extreme example, one of my son's classmates in San Francisco is growing up, with his younger brother, in a *very* small (probably at most 600 sq ft) apartment in a well-located older building. His parents got the apartment many years ago before they had kids, and rent control now makes it a great deal. I don't know how much longer the four of them can persist in this situation, but I am pretty sure their earning potential would let them buy a house in the East Bay suburbs or in an open access city, and they value the San Francisco lifestyle, warts and all, too much to make that choice.
This article hit home. I bought my first home in February at the age of 36 for $860,000 in Los Angeles. I regret doing the "responsible thing" by paying off all my student loans, maximizing my 401K and HSA contributions, and diligently saving for a 20% downpayment. Humble midwestern values are not rewarded or valued in this city. My peers who leveraged themselves to the hilt or bought with the help of their parents years ago are sitting on very healthy six-figure gains and are either trading up for homes in neighborhoods with better schools and shorter commutes.
I think Arnold misses a very important factor in this analysis, down payment.
In expensive "closed access" cities, rent is already ~half of income. In his example, even at 10% down payment, ~2.5 years is needed just for the down payment while saving the non-rent 50% of their income (actually longer due to additional costs of purchase).
What is the actual savings rate for most Americans? Certainly not 50%. Closer to 15% (generously). At 15% saved it is almost 9 years for a down payment. And during that 9 years their savings have to keep up with appreciation to not fall further behind. If, as Arnold suggests, appreciation is large due to inflation, that 9 year number will increase.
Young people without very high incomes or wealthy and generous family simply haven't had enough time to be in a position to buy a home in these places.
I'm 'familiar', personally, with this choice for NYC, and there's two other costs that I think potential buyers might also want to consider:
- Childcare
- (Potential) divorce
Even _part-time_ childcare, i.e. NOT covering a typical work day, or NOT covering an entire typical work week, or (also commonly), NOT covering either, is probably more expensive than the rent on (another) apartment. The 'obvious' workaround is for the lower-income parent to stay home with any kids. The less obvious (to me) workaround is to hire a 'nanny' 'under the table'.
Divorce is, at least statistically, extremely likely.
What about the specific risk of holding a specific real estate property? Specific bad things can happen to your property, which don't affect the macro residential market. The regime could build a housing project in your neighborhood and destroy the property value, or there could be an election-year racial tension campaign in your town, look what's happened to Minneapolis. Not theoretical and not forgotten history.
Owning property in a declining civilization is a risky proposition, and by renting, you pay someone else to take that risk. Do you buy in Rome, in Ravenna or in Constantinople? Hard to tell which is which.