Feeling Bearish in a Bull Market

Perhaps the most famous naysayer to the notion a home is an investment is Robert Kiyoskaki. Per his seminal book, Rich Dad/Poor Dad, the conventional wisdom is bunk. Committing to 30 years of mortgage payments represents a liability, not an asset. Even when owned free and clear there are associated expenses, such as tax, insurance and maintenance. Sure, you can sell, but then where would you live?

Conversely, Kiyoskaki considers an investment a passive stream of income that is profitable today, not, potentially, at some nebulous point in the future. My boss in NYC had this discipline back in 2006 when the name of the game was pay now for income streams that will “inevitably” come to fruition as rents rise every single year forever. If he couldn’t get a little bit of upside from day one, he didn’t buy. Please refer to the new book Saving Stuyvesant Town: How One Community Defeated the Worst Real Estate Deal in History for an example of how you can make a few billion disappear in less than a decade by betting on future cash flows that never materialize.

While it may be a personally satisfying to watch your predicted value rise on the realty websites, you can’t eat equity. Having Zillow tell you your house is worth a million dollars more than what you purchased it for ain’t bad. However, it is a far cry from having a million dollars in the bank.

Americans loves to own their own homes. It’s our thing – an essential part of living the dream, we are told. According to Princeton University’s The Eviction Lab 45.67% of Californian’s rent. San Mateo County is a hair more, at 46.72%. Comparatively, an article published this week by Isacc Würmann on housing activism in Europe estimates population of renters in Berlin is 85%.

But does it actually make financial sense, based on the numbers, to own a home in the Bay Area?

For people who have only followed the Bay Area housing market it might be hard to believe that people in other parts of the country buy a home to save money on rent. If you are able to come up with the down payment in the rural Illinois town where I hold property, your monthly payment with mortgage and insurance on a 70K house is about $400. Rent on the equivalent home would be at least $900.

This could not be further from what is happening right now in the single family market in the Bay. Consider a comp which closed earlier this month. It was a cheerful little house on a quiet block in Shoreview (2/1, 820 sf ft house, 5250 sq ft lot). It closed at 1.14, for an estimated monthly payment of $7665 with a conventional mortgage. This is more than twice the estimated high rent of 3800 (Redfin).

How is this justified? Asset appreciation, they say.

On a base level, this is true. My favorite Illinois rental is predicted to have risen less than 7K since 2016, and this doesn’t take into account the 7K we put into it at purchase. However, it brings in a positive cash every month like clockwork.

Compared this to a home sold in San Mateo in 2016 which is said to have appreciated 533K in the same amount of time, or 38%. Yet one should take out the approximately 125K in interest paid in the first 5 years of the loan. Now, from the 408K remaining you can back out the commission at 4.5% of the sale price and you are down to a profit of approximately 319K, or 22% over 5 years. This also assumes no other capital expenses in that period (HA!).

Additionally, unless you sell, it is hard to call it an asset when the expected fixed monthly payment is over 7K a month and the expected rent per month during the equivalent period was around 5K. If you aren’t living there, you are losing actual money day in and day out for the benefit of counting on the future benefit of undeterminable gain. If you are living there, you still ought to back out the 2K a month for the 60 months you have been paying more to own than rent from the profits. Down to a profit of 199K, your return at sale would be predicted at closer to 13.7% over 5 years. The situation does not improve if you are subject to capital gains.*

If the psychic value of being a homeowner outweighs the math, go forth and own my friend. Ditto that if you have piles of cash or an overwhelming fear of inflation. Otherwise, Kiyoskaki’s point on the heavy liability of homeownership is worth considering in the heat of the current bidding environment.

 

 

*Yes, there may be SALT tax benefits to consider, but they have been capped now. Also not included in this model is the impact of closing costs, such as staging, as well as the unexpected costs of ownership which tend to crop up all too regularly, such as appliance replacement, mold mitigation, window replacement, yard maintenance...