bostonbubble.com

[GD]

So...we made an offer on a new development townhouse we really like. It was rejected as insulting. And the selling agent kind of threatening imply we don't want to start off on a bad relationship with such a good builder if we like his house.

Should really have waited instead of offering - 6 months of lurking in this forum and reading news/reports have convinced me prices in metrowest are overdue a correction. But my emotions got the better of me. I'm 100% convinced renting is cheaper - over here, I've calculated it'll take about 24 years to recoup property's cost as a landlord. This is peculiar to a few places only, like Boston's metrowest. Other parts of the country have much higher rental yields, 12-15 years is the norm. But...really like the townhouse lol.

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Hubby was quite upset, he seldom likes a house as much as this one. I like it a lot too, enough to override my concern about value. Value is what I'm looking for when buying, even though we're first timers. I have no intention of overpaying just for the privilage of owning a property in MA lol.

Our first offer was already higher than I think the property was worth, and we'll be willing to go a bit higher too. But if he's insulted *now* he won't like the next offer (which will be near list price!) too.

How the heck do you offer for a new build here? Other parts of the country, it's recognized that for new builds, you pay the list price + builder throws in upgrades, varying the amount depending on economy. Some of the upgrades we ask for are considered standard in many luxury townhouses, but builder had priced them as an upgrade option here.

We offered >90% of list price btw. He has a few units in this new development. The others were listed at 5% LESS than our offer price, even though they were largely identical. He marked this with a 12% premium.

A few towns away, in an almost equivalently good town, there's a townhouse development listed for the same, about 20% bigger total square footage. That builder was willing to sell his unit (a less desirable one in his development) for list price, and he'll finish the basement. Some of the upgrades "here" are considered standard "there". So I dunno...this one feels like a really bad value. Agree?

So...I'm trying to comfort us by making an extra nice dinner for poor hubby today.

Don't know what I'm looking for. Advice, tips, commiserations... Renting is much cheaper. I was hoping for the stability of ownership. With family here, it's quite tough to decide to relocate even if other parts of the country is cheaper. We're an average, 30-something, moderately paid professional couple. Having to face the fact that we need to either pay 2-3X people living elsewhere do, or that we're really lower middle class here, is a hard pill to swallow!

[CL]

I cannot see how a >90% listing price offer is insulting. Both you and the listing agent know 1) typcial transaction price last year is around 90-95% of listing price and 2) newbuild has more time pressure to sell since it is vacant (unlike existing owner that can stay at home for a while). If the seller is not willing to negotiate and you are not willing to pay listing price, then look elsewhere. There are plenty of new townhouse in MetroWest, and trust me you will find another house you love.

Regarding rent vs buy, people keep saying renting is much cheaper. I think it's a matter of time horizon. This is the website I used (besides the spreadsheet I create myself), from NY Times -

http://www.nytimes.com/interactive/business/buy-rent-calculator.html#

[GenXer]

On a risk adjusted basis, renting is MUCH CHEAPER. I will say it as many times as necessary because it is true. The NY times calculator is completely useless. I'll say that too. That is because nobody knows what the future holds, and your PREDICTION ERRORS will be humongous if you try to predict more than a year into the future (i.e. interest rates will change, prices move in a non-Gaussian fashion, etc).

Proof is in the pudding - make a TINY change in your initial conditions, and your results will be wildly different EVEN for this static calculator. Imagine what happens in real world - you will need a Monte Carlo simulator with non-Gaussian house price variations to actually see ANYTHING about your future chances. Therefore, this calculator is worse than useless - it shows one out of a million different scenarios, all of which could be worlds apart in terms of the outcome. But for those who KNOW this, the calculator is just a useful estimate that can be ran a bunch of times to generate upper and/or lower limits (which still have such a wide spread as to make them meaningless, yet informative even if for the purpose of demonstrating the risk of buying a house).

So in other words, buying a house is a huge gamble, given that you are not hedged in any way (and that most people have no real savings after that). This means that risk plays a bigger role than people realize, so even in the best case scenario, on a risk-adjusted basis renting is cheaper, because as we discussed before, with rent you pay for portfolio and unemployment insurance of sorts.

As far as new construction, its a lost cause here because there are still a lot of people with money who plunge head first by paying any asking price. Until that changes, new construction is probably off-limits to most people on this forum.

By the way, buying a house is not going to give you stability if anything. It will give the stability to the loan originator and the seller, yes, but you will be anything but stable. Maybe geographically, yes, but not emotionally. If you have any friends at all here, you probably know that many people lost their jobs, and there is no such thing as a stable job nowadays. I know I sleep better at night knowning that I can always downsize or move to a cheaper town if necessary. I know plenty of people who are basically loan slaves.

[CL]

GenXer - I understand your point that renting involve less risk and buying involve more risk, and to truly assess the risk involved you need Monte Carlo simulation to play out scenarios. That I agree.

That alone, however, does not make renting cheaper. It just makes it less risky. To truly assess the risk/return tradeoff, you need to look at Sharpe Ratio type metrics for both renting and buying (possibly from result in Monte Carlo simulation).

I trust you are not making a highly convicted sweeping statement (Renting is much cheaper) without solid analysis to back it up. So I assume you already made a risk adjusted analysis between risk and return on both renting and buying to come to this conclusion. I would love to see your calculation and methodology, if you don't mind showing it.

[GenXer]

Sharpe ratio works for a stationary Gaussian random process.

House prices are non-stationary non-Gaussian random process with fat tails.

If you don't believe that - just throw a CDF for a Case-Schiller index on the Gaussian CDF and you'll see what I mean. I'm sure you know what fat tails are and what they imply.

It is impossible to create this type of analysis without making too many assumptions, but I think that the following argument will clarify what I mean.

Using Sharpe ratio as an example, actually, is probably best. Suppose that your standard deviation can grow without bound - that is, your risk can blow up when you least expect it. This can happen during a crisis, for example. This means that 99% of the time, your Sharpe ratio will be relatively constant, but 1% (these are just example numbers) of the cases will see your denominator blow up. This is exactly what we observe (see Mandelbrot 1962, for example - your variance can be orders of magnitude different).

When I say 'risk adjusted', I mean adjusted by the real risk, not some fake Gaussian risk. Because we DON'T KNOW what the upper bound is for the risk, we have no idea how much riskier the worst case is than the 'normal'. This means that we always underestimate risk by orders of magnitude.

While this is not true most of the time, during the times when this is true, you are in trouble. Of course, this is somewhat simplified, because the risk involved here has to do with many more variables than the house price (and I alluded to the fact previously by noting that the risk is not simply a probability of loss, but a sum over probability times the magnitude for all of different risks including loss of job, unforeseen expenses, etc).

As far as Monte Carlo analysis, it would be much more informative, yet still hopelessly wrong because we do not know what the future holds, and any one sequence can be just as probable as all the other ones. Your prediction errors would be unacceptably large to draw any reasonable conclusions (other than understanding how big the spread could be between the best and worst cases).

The reason I'm saying that renting is ALWAYS cheaper is because the risks for owning are very much underpriced, even though we know they can lead to massive losses and bankruptcy. In my book, this kind of payoff is unacceptable without proper risk management (which is rarely if ever done), hence for people who don't do the proper risk management, buying is always going to be worse than renting, given the risks they are taking.

This is the best one can do, I'm afraid, as far as analysis. A bad tool is worse than no tool, I'm afraid.

[CL]

If you use Sharpe Ratio to look at the result of the Monte Carlo simulation, ie run 1000 iternation based on some random home and rent price changes, and look at mean and stdev from there. The result from Monte Carlo should be stationary Gaussian even house price is not, and Sharpe Ratio should be fine to use in this regard.

I understand your concern about tail risk - and to be fair it is a legitimate concern. I just think, on a pragmatic level, you can see tail risk in anything. Air travel is 99% safe, but when it does not you usually die. That does not mean flying is always a bad choice on a risk adjusted basis, in your book, right?

You said renting is always cheaper because risk of owning is very underpriced - but to come to this conclusion you still need to price risk of owning, especially the tail risk. How? Without a price one cannot make cheap/expensive comparison.

[Guest]

Did you guys read this news?

MA Housing Partnership: Around 64,000 distressed properties
http://www.boston.com/business/articles/2010/03/11/a_recovery_threat_in_the_shadows/

Here is the link to the MA Housing Partnership's report.

http://www.mhp.net/vision/resources.php?page_function=detail&resource_id=380

"In Nov. 2009, the Federal Reserve Bank of New York identified 19,652 prime, 10,719 sub-prime and 2,951 Alt-A loans, for a total of 33,322 mortgage that were 90+ days past due/delinquent. It is important to note that the New York Fed data does not cover all mortgages. Projecting their totals across all mortgages, there could be approximately 54,000 to 65,000 delinquent mortgages in Massachusetts."

"Legal Ruling to Slow Foreclosure Completions

In October 2009, Judge Keith Long upheld a lower court ruling invalidating foreclosures where lenders/servicers had not properly filed transfer of mortgage ownership at the Registry of Deeds. The Massachusetts Real Estate Law Blog has a description of this process. Among the effects of this ruling are:

· Families that have lost their homes may be able to challenge the foreclosure
· Foreclosures may be stalled by the lender in order to file additional paperwork at the Registry of Deeds. This may include re-filing a foreclosure petition
· Lenders will begin to file the proper paper-work on all properties which in the short term may delay foreclosure proceedings on delinquent mortgages. "

It sounds like there is a lot of houses in pre-foreclosure.
I wonder when these houses will finish the foreclosure process and come out in the market.

[GenXer]

CL: If price changes are fat-tailed, you will need to put that into the Monte Carlo, and you certainly will not be able to use standard deviation (2nd moment) as a measure, hence you will not have a stable Sharpe Ratio.

But that aside, you have a point. I would argue that the risk of flying is not a fat tailed distribution, just like driving a car. Yes, the worst case is death, but even if it is Gaussian, doing it for a long time will increase your chance of getting killed in a plane or a car crash. Its just that it is not very likely to happen. We don't have a million fatalities from car crashes (~40k a year), and even less from plane crashes.

On the other hand, when you buy a house for 30 years, you are simply waiting for trouble, as there are very few upside events (prices going up), and many more downside ones, just as we discussed previously by comparing a house to a leveraged security. This is why we have MILLIONS of foreclosures, and the chances are a LOT higher, and are therefore owning is severely under-priced compared to renting.

By definition, fat tails risk can not be priced appropriately - this is why the only way to NOT be subject to it is not to play! Or, alternatively, if you do decide to play - hedge and cover the bottom. That is, buy a house with cash, or have a very large backup cash reserve (and of course, buy something you can afford even if you lose your job to begin with).

This is more of a philosophical question than a quantitative one. If you know you can lose a lot more than any calculator can tell you, how will you protect yourself?

My argument is that anybody who buys houses as if they were cars is just waiting for trouble, because they have no idea what they are getting into as far as risk.

[CL]

GenXer - agree that most people do not aware of the risk home buying assoicate with. I think it will be great if some Wall Street firms can create way out of the money options on C&S city index, so you can partially hedge the tail risk. Other than that, there is not a lot I can think of to manage the tail risk.

I do fully agree one should have a big down payment (25% or more to withstand market volatility) & a sizable dedicated cash reserve (probably 2 years of mortgage payment) to service the debt. High leverage kills. Too bad people don't realize it.

[Boston ITer]

[john p]

GenXer:

The typical younger home buyer is basically scraping by (unless their parents paid for their college). It would take over a decade to cover this type of down payment, and another decade to get the emergency fund you're talking about (unless you're investing in something pretty risky).

Should someone game plan a certain percentage of their emergency fund to be a planned withdrawl with penalty from a 401K?

[lucidguppy]

What I'd like to know is who's buying now? Do they have the buffer or are they people who've learned nothing from the crash?

[GD]

I'll buy if the price is right, or in the case of MA, less wrong.

Dinks making about 100K after taxes.
In our 30s already, been renting/working 5 years, saved up a good downpayment + 1 year expense + retirement savings. I think we're in a good position to buy and not be unduly overextended...in most places except MA anyway.

Our incomes are unlikely to double or grow substantially.

Will buy in a heartbeat in the areas with sufficient price decline. Just not MA - with family here, it's really hard to pack up and just leave for a cheaper state. Is that why most people stay in MA?

I don't understand why prices here are still so inflated relative to the rest of the country. Jobs are lost here, just like elsewhere, according to every metric I've seen. Houses are still close to prebubble prices for the most part in metrowest.

It's possible that high tech jobs are still pretty secure in this area, less layoffs. I've seen some layoffs in the company, but not to the extent advertised in the news.

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BTW I'm the OP. Offered >90% BUT also asked for upgrades. I priced out the upgrades independently and figured builder's margin on that is like 25%.

However, I offered more than the other unit builder was trying to sell. He tagged on a 12.5% "lot premium" to this unit, identical in size to the others, but in a better location with a walkout basement. I figured lot premium was negotiable.

Some of the "upgrades" also included things that I thought should be pretty basic at this price "luxury townhouse' price point, because we've been looking for 2 years and even came close to buying another townhouse development. And in those townhouse developments, these were pretty much standard. Example: tiled instead of fiberglass tub/shower, hardwood floor....

Anyways we're still looking, and will buy a low maintanence house and pay a small premium over properties in other states because we want to remain in MA. I don't think our case is unique around here. Everyone around us are urging us to buy, and have either purchased or bought a property of their own.

People still need a roof over their head in a decent commuter location to get to jobs. I'm also afraid of landlord raising rents suddenly by a lot - no law against landlords forming a coalition and raising rents by 10% acrossboard. Why shouldn't they?

If we were in a state with actual price decline, such that house price is a more rational multiple of income, we'd have already purchased a property.

:>

[GenXer]

GD: It is true - one reason people do stay in MA is because of family (who own a house they bought a long time ago). No problems with rents - these are very competitive, and there is NO WAY somebody will raise them 10% in a down market. If anything, they are tripping all over themselves trying to lower rents. I see rents coming down in a matter of months. You can always sign 2 year leases - that's what I've been doing. My landlord raised my rent 10% in 4 years because I negotiated 2.5% (roughtly) increase a year and signed 2-year leases. Good landlords dig good tenants and will NOT want to see them go, especially in this market for a couple of extra bucks (if they do - something's fishy and they may be close to losing the place anyway).

john_p: 401k withdrawals? If you need these to fund a house, you got your priorities out of whack. I wouldn't touch a 401k unless you have to post bail (or for something very serious). Besides, if you know you want to blow your cash on a house, why contribute to a 401k? Plenty of people cash out their 401ks for a less compelling reason.

Yes, it may be a lot of cash, but lets face it - most people don't make long term plans and they also waste much of their income on stuff they don't need (including buying houses they can't afford). So it does take a special mindset to be able to afford a house in MA. It is true that a spender will not be able to afford a house in MA. It is also true that somebody making less than $100k will have a harder time, but if you've been saving since you started working, and if your spouse is the same way - that's all it takes. Unfortunately, opposites attract, which is also true when it comes to finances (for the most part).

[CL]

Boston ITer - I can tell you saving that amount of money is actually quite possible, indeed not that hard at all, if you are willing to live with your family after college. You save the money for your annual rent (15-18K) every year and put it in a high saving account/CD at 3% interest. After 10 years, you have 206K saved. That's around 30 year old.

If living with family is not possible, how about renting an cheap apartment with 2 friends at 3 bed apartment at around $2000, instead of renting a one bed apartment at $1500. You save the difference, and get around $170K in 10 years.

The key is to save aggressively for an extended time of year, and you will discover you can get there much sooner than you realized.