bostonbubble.com

[admin]

[balor123]

Boston consists of more real estate markets than Cambridge. At $1500 - $2000 taxes for a $450k place, Cambridge is way below most Boston neighborhoods. Schools in Cambridge aren't good. You're also assuming that rent prices are stable. Rent prices are abnormally high for two reasons: (1) FTHB not buying and (2) seasonal adjustment. In Waltham, I can rent a nice 3br place for $1800/mo or buying a nice 3br place for $450k. With rent I get more - gym, heating, cheaper insurance, etc. You are also assuming that because home prices are near rent prices that rent must also be affordable. It is not, which is why people are leaving the state. Cost of living in this state is way above other states and quality of housing is considerably lower as well. Housing prices are only one factor in that cost of living and it seems that cost of living is only going up (all these young home buyers have to buy health care now for example). You are right that the analysis shows that home prices are near rent prices. They are near but not equal. Under your best assumptions, buying is still a little more expensive. For this reason, the futures don't predict huge drops in home prices but a gradual decline. Like the admin said, economic conditions are good in Boston right now. That is changing. Transportation inflation is killing properties far from Boston. Educational inflation is pushing down rents. Medical inflation is also very high. At least for the next few years disposable income is likely to go down, further reducing affordability. One issue that isn't mentioned enough is the high likelihood of another war in the Mideast.

[JCK]

[Guest]

A couple things.....

(1) The data about housing prices dropping in Charolotte and Dallas is in the Case Schiller data. I'm not going to post it here but you can get it online. I'm not sure there are year over year declines yet but on a monthly basis those markets are going down. The only reason I can see for this is the negative psyhology now at work. Whereas a few years ago, people were goo goo and ga ga for housing, now people talk about it as if it is the worst investment in the world.

(2) Regarding the risk of buying a house now, I think the risk of price declines is omnipresent from a market perspective. Is the risk higher now than it was in 2004 or 2005? I think the only way to address this risk rationally is to look at the fundamentals. To me, this involves looking at the cost of owning versus the cost of renting. The math definently favors owning over the long term (say 10+ years). I think it favors buying for 5+ years. Five or less is likely to be a wash of a loss. This is different, however, from the question of whether one is better off waiting six months or a year or two to buy. Buying in one year may be better than buying now but owning for the next ten years is still better than renting for the next ten years... A subtle but important distinction that seems to get lost a lot.

(3) I think the real interesting variable for analysis her is interest rates. My thesis is that much of the runup in real estate values has to do with lowered long term expectations of the interest rate range and volatility. The future will tell us whether these expectations are right or not but I think if interest rates continue in the range they have been for the last ten years there is no fundamental justification for a big drop in housing prices (below where they are now). Anyone else have some thoughts on this issue?

[admin]

[Teavo]

Here is an excellent, full-featured buy-vs-rent calculator that you can use to test out your theories: NY Times Calculator

I think you'll find that it's still not a good time to buy a house in the Boston area.

[Guest]

I'd be interested to know what inputs you used to show that buying doesn't make sense according to this calculator.

I see that using real numbers and assuming a 3% increase in rents and 2% increase in housing prices, owning makes sense after in 3-6 years. Now you might say I should estimate a 20% decline in housing prices but that defeats the whole point of the analysis. Assuming housing appreciation slightly below inflation is quite conservative and if this assumption yields the result that owning is less expensive than owning after a few years (and much cheaper in the long term) I think this implies that housing prices are now far removed from fundamentals. Only in a few isolated periods would someone make much money (or even break even) if you sold in less than 5 years. Just because owning a house for a year will lose you money, doesn't make it a bad thing to do generally. I'm using real numbers except the appreciation and the implied rent (but I varied that to test the sensitivity).

There was an interesting article I saw recently that looked at the long term financial gains of home ownership and found that housing was really underpriced. The analysis is basically that over a 30 year period the financial benefits that accrue to homeowners exceed what one might reasonable expect in financial markets based on the level of risk. Perhaps one is underestimating sweat equity here and some other things but I think the NYTs calculator bears this out. While the short term might be murky, the long term gains are pretty much universal and significant with any reasonable inputs I could imagine (even negative rental growth).

[admin]

[JCK]

My general experience with these calculators is that, if assume prices will drop, the correct answer is always: wait to buy.

If you have a 5% drop in housing prices (say your $400k home drops to $380k) there's no way, in the short term, that you will be better of by buying now as opposed to later.

Keeping the home for longer obviously tends to minimize this risk. If you're planning to buy and hold for 15 years, then I'd worry about the possibility of a5% drop a lot less than if you're likely to move in the next three years.

Of course, calling the top or the bottom of a market is no easy task.

[Guest]

I don't think it is circular to assume a 2% increase in prices and 3% increases in rent. Assuming a 2.5% inflation rate (this is the NYT default), these seem about what one would expect is a balanced market. Using other inputs from the real world (what I paid for a condo, my condo fees, property taxes, closing costs, estimated maintaince) and what I would expect to rent the same place for (rent and deposit required), I find that crossover is in the 3-6 year range, depending on how certain figures are varied (downpayment, interest rate, assumed rent, etc...). If the cost of renting vs. the cost of owning yields such a comparison assuming the normal rates of appreciation, this would seem to imply a market that is much more fundamentally balanced than many are led to believe. Based on these fundamentals, I don't see the argument (based on fundamentals) for further declines unless people inherently strongly prefer to rent (I think the opposite is true). This is different from making an actual prediction based upon how irrational people in the real world are going to act. I think the fact that everyone assumes housing prices will drop in the near future will in fact drive them down, just as the opposite were true in prior years. The point of this analysis, however, is to differentiate between those kinds of declines (which should be relatively short lived because they are really based on fear and not the fundamental value of housing) and those that are permanent declines from an asset bubble. Assuming there will be price declines (because that is what everyone says) will set up an analysis that will show that buying is always a bad idea. This is the same thing (in reverse) as assuming that housing will always appreciate at 5-10%, which will always tell you to buy immediately. Again, this is why I think it correct to assume the appreciation of rents and prices that I did for the kind of analysis I'm trying to accomplish.

[admin]

The reason I think that there is a circular aspect to it is that you only get your 6 year break-even time frame by assuming appreciation, or as you put it, assuming we are already in a balanced market. One of the underlying questions that this raises is what has the break-even time frame been in the past? Is it normally 6 years? What if it has historically been 3 years (I have no idea)? If that were the case, we haven't passed beyond equilibrium yet.

I do agree that the market is likely to over-correct.

- admin

[balor123]

You're also assuming that rents are reasonable. They are not. MA has one of the highest costs of living in the country, in part due to rents which increased in the late 90s. Despite the tech bubble popping, rents haven't come down in part due to high real estate prices. Rents in Boston are comparable to those in Silicon Valley but without their pay. The result of this high cost is that people are leaving in masses:

http://www.boston.com/news/local/articles/2008/05/18/at_a_loss/

Not just anyone is leaving - first time home buyers. The housing market is at a stalement right now - little inventory is moving. Buyers are waiting and keeping rents high and home owners are waiting keeping housing prices high. Eventually one will have to give and buyers can leave the state. Whether they start buying or leaving, rents will start to drop which will put pressure on home prices to decline. Combine that with stagnating income, lack of development (no credit or permits for builders), further foreclosures, recession, retiring baby boomers, and rising inflation and there is little reason to believe that prices will rise much over the next 5 years. Put it a conservative 0% gain (negative over the next year making up for slight uptick over the subsequent years) and you'll see that the time horizon is more like 10 years. First time home buyers don't want to be stuck in a 2 bedroom 900 sq foot starter home for a decade. As far as I can tell in Waltham, no starter homes are moving. Four such places on Bacon St on the same block all on the market for 6+ months.

[Guest]

It is circular to show that prices will drop by assuming that prices will drop. It is not circular to try to evaluate which direction things will go by seeing what the cost benefit equation for buying vs. renting looks like when one assumes a steady market (actually slightly declining as I assumed 2% appreciation with 2.5% inflation).

I think people lose sight of how the fundamental and most important thing about housing is that you live there. This is where most of the value comes from. You'll hear lots of people say that housing is a terrible investement because it has only appreciation at the rate of inflation historically (or something like that). What they are missing is the rental yield that accrues each year while you are living there.

Regarding rents being inflated, I think this is a bogus argument. Unless there is some monopoly of landlords (which there clearly isn't) then there is any credible reason for resdiential rents to be inflated. Commercial tenants will often sign long term leases that have built in escalations or are premised on the future trajectory of the real estate market. Residential tenants renew leases each year. If someone is really getting a bad deal, they will move. Rents are high because of supply and demand. Desirable locations in the Boston area could easily be at 100% occupancy. They are a little below that because the landlords make more of a profit at 95% occupancy with higher rents.

This is why using the rental value of property to estimate the price of housing seems like the most fundamental approach. This analysis can lead you in different directions depending on the assumptions you make-most importantly interest rates and the question of what sort of return homeowners will demand. Other than that, you are dealing with mostly hard verifiable numbers that are grounded in the real world.

[admin]

[JCK]