Jumbo Mortgages?

According to the calculator, the monthly carrying costs are about $9k/month with a 6.5% mortgage. Add to that a return on your downpayment -- say 8%, which would get you corporate bonds that are significantly less likely to drop in value than this downpayment -- that's another 2k/mo.

So you are paying about $11k/mo to live here -- and far more if prices drop between when you buy and you want to sell and you lose much of your downpayment.

Even after the tax subsidies to leveraged homeowners, that's significantly more than comparable rentals. Also, it's more than it would cost a developer to build a modern building that some people would view as comparable or to convert an older rental or industrial/commercial building to coops or condos.

This price is too high. So it is likely to go down. Which means that the above calculations are too optimistic; it is going to cost more.

Posted by: FinanceGuy at July 7, 2009 3:59 PM in response to Co-op of the Day: 27 Prospect Park West

Benson: Inflation is very good for debtors, so if you think inflation is coming in a big way, you might want to get in debt.

The easiest way for small scale investors to do that is to take out a mortgage. However, I wouldn't buy an overpriced house just to get a mortgage. Coming out of a bubble, inflation would likely make REAL house prices drop faster: sellers will resist the inevitable drops less if they are only in real, not nominal, dollars. Or put differently, there is no reason to imagine that an overpriced house will go up with inflation. It'll just stay still until the underlying costs (rents/construction) catch up.

However, before planning an investment strategy based on runaway inflation, keep in mind that the Fed is fairly powerful and deeply dedicated to restricting inflation, at least when it reaches ordinary wages. The Fed knows it can always raise interest rates as high as necessary to create a recession big enough to squelch inflation, and it has demonstrated that it is willing to do so. So a bet on runaway inflation is a bet on major political change: that the Fed won't use the tools it knows best in the cause it believes most in.

I'm not very good at predicting macro stuff, but if I were in a pessimistic mood, I'd be more inclined to worry about (1) deflation (because that is what is happening now, and the Fed doesn't have guaranteed-to-work tools to deal with it), and (2) a dollar collapse (because we buy more from abroad than we sell, and eventually the manufacturing countries will want to paid for the stuff they're selling us, which means we need to sell more, which means the dollar has to get cheap enough that our exports are competitive).

Deflation makes debt extremely painful: it's hard to pay back a loan when the asset backing it, and the income that is supposed to pay it, are dropping. It's deflation that put the Great in the Great Depression. If we head that way, you want to have lots of cash and to stay employed and to pray the government acts decisively.

A drop in the value of the dollar strikes me as unavoidable. We can't buy more than we sell forever. But it is largely a matter of market psychology and Chinese domestic politics whether the drop will be deferred until the recession is over and then be comfortably gradual, or come as a sudden whoomp one weekend in the near future.

I have no idea what the impact of dollar drop or collapse would be on NY real estate. I guess our tourism business would go up, and our houses and investment banks would be cheaper for foreigners to buy, which might increase demand, but on the other hand any foreigner already invested in NY would lose money, which might make others worry about investing here, and decrease demand. Medium term, it'd help manufacturing in the US, which would probably hurt NYC relative to other US cities that still make things. How big would the relative impacts be? I don't know, but even if demand increases, it is unlikely to revive the bubble.

Inflation, deflation or dollar collapse -- there is no reason why home ownership should cost more than renting a comparable space. On the contrary, if people are worried about any form of economic instability, the price of economic assets -- especially NYC real estate that is valuable/habitable only if the government functions well -- should drop. Fearful people rent.

Posted by: FinanceGuy at April 30, 2009 8:56 PM in response to The Ripple Effect of Northside Piers' Price Cuts

GWH:

Zoning can't explain why owner-occupied properties are more expensive than rentals. We don't have any significant zoning restrictions on changing one into the other.

If zoning really restricts building in NYC more than elsewhere (which is not clear to me: we have high rises and mass transit, which suggest that it might be easier to build densely here), it would help explain why NYC is more expensive than unzoned regions.

But I didn't argue that NYC is overpriced relative to less zoned areas. I don't know how to value the relative attractiveness of cities enough to do that.

(The more standard term is equilibrium price, but I wanted to emphasize that the argument is asymmetrical. There are strong market pressures preventing prices from staying above the equilibrium price, where owner's price = rental investor's price = marginal cost of production = marginal cost of conversion/rehab, for long. The pressures preventing it from staying below that point are far weaker.)

Posted by: FinanceGuy at April 30, 2009 8:13 PM in response to The Ripple Effect of Northside Piers' Price Cuts

As long as prices are higher than construction costs, developers can make profits by new construction -- and some will.

As long as land prices are higher than the available uses of vacant land (gardens?, parking lots?), landowners can make more money by selling to a developer -- and some will.

As long as owner-occupants are willing to pay more than renters, landlords can make a profit by selling rental units to owner-occupants -- and some will.

As long as owner-occupants are willing to pay more than commercial or industrial users, developers can make a profit by converting -- and some will.

Each of these increase supply. Even if other owners hold out for higher prices. More supply, same demand, means that some sellers will be unable to sell at current prices. Some of them will cut their prices to make the sale. Those who hold out, won't sell.

The pressure to reduce prices does not end until prices are no higher than the cost of producing new supply. So, if you want to make a pretty good guess about the maximum sustainable price for housing in NYC, calculate the cost of construction, conversion or rehab. The lowest one wins.

This is the equilibrium ceiling. Friction (it takes time to create new supply) combined with rapidly growing demand fueled by a mass belief in perpetual motion machines (buy now or forever be priced out/RE only goes up) can sustain prices above the equilibrium ceiling for a while - we've had them for most of a decade.

But prices above cost of production are not stable. Eventually, profit seekers will find a way to meet the demand.

Reduced demand -- due to difficulties in borrowing, bonus, employment or income drops, or cuts in MTA service -- could lower the equilibrium ceiling (e.g., by reducing rents), or even push prices below it too (see, e.g., NYC from 1930-1980, when prices were well below replacement cost).

If you buy above equilibrium during a bubble, you are basically betting on friction and irrationality: that you will be able to sell to someone else willing to pay more (because they expect to find someone else willing to pay even more) before development/rehab/conversion/rezoning/boundary changes increase supply to meet demand. Or you are demonstrating a great faith in perpetual motion machines.

If you buy above-equilibrium prices after the bubble has popped, you are paying a very large amount of money for the right to live in the place in the near term before price adjustment happens. Or you are betting that adjustment will happen by rents and construction costs rapidly rising to meet current sale prices.

Markets are not efficient and they can take a long time to adjust. However, the trend today is downward, and there is nothing visible that could reverse the downward trend above the equilibrium ceiling.

I have trouble seeing rental values much over $375/psf anywhere in Brownstone Brooklyn, and that's doesn't seem far off construction/conversion/rehab costs either (at least excluding bubble-prices paid for development sites). Those with better numbers will correct me, I'm sure. Why won't Adam Smith take us there?

Posted by: FinanceGuy at April 30, 2009 2:29 PM in response to The Ripple Effect of Northside Piers' Price Cuts

Owner financing: Bklnite has the mechanics right.

In the bad old days, when most of brownstone Brooklyn (and Manhattan) was redlined by the banks, owner financing was the only way to get a sales price over what buyers could pay in cash. Owner financing was standard until the Civil Rights Act ended redlining in the late '60s.

Generally, sellers will only agree to owner financing when they and the buyer strongly believe that the property is worth more than the banks do. So it hasn't been an issue in the financial bubble years.

Recourse/Deficiency Judgment:
Mortgages are recourse in NY, but I think not fully -- I believe the lender is allowed EITHER to sue on the debt (and collect from the borrower) OR to foreclose on the house, but not both. So no deficiency judgments.

If I have the law right, you would expect lenders nearly always to choose to foreclose. The house is usually going to be worth more than you would get from chasing around an insolvent individual debtor. And banks are bureaucratic enough that they'll rarely even look for the exceptions.

Posted by: FinanceGuy at April 29, 2009 3:16 PM in response to Price Cut at 273 Berry Street

BRG asks
"'with it's million dollar view'
So without a view, do you knock off a million bucks??"

Answer: Yes. Or a bit more.

Posted by: FinanceGuy at April 21, 2009 4:54 PM in response to Co-op of the Day: 75 Henry Street

ontheparkway: the numbers have a high fudge factor -- the difference between 6% and 12% is huge -- but the fudge necessary to get to HALF this asking price is rich for my taste.

Posted by: FinanceGuy at April 21, 2009 4:49 PM in response to Co-op of the Day: 75 Henry Street

fsrq: Rent/buy ratios have been out of whack since about 1995, when the current bubble started to take off here and nationally. A very LONG time for a very big bubble that is likely to have a very unhappy ending for people who assume that it is going to continue forever (or think that prices are up since '06).

As for the "social dislocation" -- seems unlikely to me. BH was a pretty nice neighborhood the last time prices were at that level. In any event, do you really think that the bubble buyers -- most Wall Streeters, in the last few years -- are going to turn to (violent) crime if they lose their home equity? Or is your fear that the rising middle class, suddenly able to buy middle class housing for middle class prices, will take to the streets in protest?

Posted by: FinanceGuy at April 21, 2009 4:41 PM in response to Co-op of the Day: 75 Henry Street

dar16 -- What did it sell for?

Posted by: FinanceGuy at April 21, 2009 4:31 PM in response to Co-op of the Day: 75 Henry Street

ontheparkway: The long term statistics are limited and I don't know of any for NYC, but they show pretty consistently that over long periods over many geographical areas, homeowners about the same as renters. Google Shiller for the best charts. Anything else would defy Adam Smith.

(Some US studies that compare median rents to median owner occupants show the owners paying more, but that is because they aren't adjusting for the difference in quality between the median rental and the median suburban split-level. When they correct for quality, they show that ordinarily, annual rents are 1/8-1/10th the cost of comparable houses.)

In NYC, comparable rentals are available in all price ranges. Based on my anecdotal knowledge, from at least WWII until 1995 or so, owners almost always paid less, after the tax subsidy, than renters for comparable places. With the exception of the mini-bubble of the late '80s, usually dramatically less.

Owners, after all, take a bigger risk than renters, invest more money, lose the opportunity to invest elsewhere and are less diversified. Rational buyers ought to refuse to take those risks unless they are paid for it.

Posted by: FinanceGuy at April 21, 2009 4:30 PM in response to Co-op of the Day: 75 Henry Street

The price is delusional. Streeteasy shows a 3 BR in this building that sold in '06 with a final ask of $1.2m. Prices have not gone up 1/3 since '06.

An investor expecting to make 8% wouldn't pay any more than $550k for an apartment that could rent at 5000/mo and has a maintenance of $1384/mo.

Even in a coop that cannot be rented, rental value should be the basis for an owner-occupant's calculation too, because rental value (or less) is the market equilibrium price.

Rental value is key, because in NY there is an ample supply of comparable units that investors can easily change from investment into owner-occupied. If owner-occupants are willing to pay more than rental value, investors can make money by selling out to them. Some will. That will increase the supply of units for sale to owner-occupants. More supply means lower prices. Prices should keep dropping until all units are owner-occupied, or the rental value is no more than the owner-occupant value, whichever comes first.

If you pay more than current rental value, you are betting that the market will never reach equilibrium or that it will reach it by rents going up rather than prices going down. As we've seen, bubbles can lead markets to move far away from equilibrium. But they can't do it forever.

To justify this asking price, you need to believe that the rent for an equivalent to this apartment will reach 12k/mo in short order. Or you need to believe that NYC is exempt from the usual rules of market economics.

Posted by: FinanceGuy at April 21, 2009 3:51 PM in response to Co-op of the Day: 75 Henry Street

Contrary to DIBS's version of "Econ 101", no economic theory suggests that a decline in sales volume due to sellers asking bubble prices will lead to prices "strengthening".

The end game in bubbles is a pop. We aren't there yet.

Real estate prices reach equilibrium when investors -- not homeowners -- are indifferent between buying to hold-and-rent or selling to homeowners (rental values equal ownership price). Brooklyn prices are still far above anything a rational buy-and-hold rental investor would be willing to pay. Even if rents don't drop further -- which seems highly unlikely -- sales prices need to drop 1/3 to 1/2 in most neighborhoods to reach equilibrium. (More in Brooklyn Heights if yesterday's house of the day reflects the current sale market.)

But bubbles don't often end at equilibrium. The manic going up is replaced by depressive going down. Prices typically drop until buy-and-hold rental investors see screaming buys, so dramatic that they are willing to take the risk of still more price drops.

And this bubble is likely to be worse than average for Brooklyn. On top of the usual debt-fueled speculation and speculation-fueled faith that prices will always go up that characterizes every bubble, we had an enormous growth in Wall Street related money that is now going into reverse.

Wall Street/finance firms accounted for less than 10% of corporate profits a decade ago and 40% at the peak. Our crony capitalists will fight hard for government welfare to keep on going, but in the end even the US Treasury won't be big enough to fund them. Wall Street is going to shrink back to 10% or, if the politicians can buck their masters before we are all pulled into a major collapse, even less.

And so NY real estate needs to adjust not only to the collapse of the real estate bubble, but also to the collapse of the industry that supplied whatever real money and real demand underpinned it. That's why rents are dropping -- real demand is dropping even as real supply keeps increasing (due to new construction, conversions from stabilization to market, renovations, expansions of the areas middle class people will live in, etc).

Demand is down. Supply is up. Inventory has doubled in Manhattan, but the shadow inventory is up far more. Tax collection is dropping and will drop far more next year as bonuses dry up and the real estate transfer tax fades away -- so the City is going to have to cut services and, therefore, quality of life. Salaries and rents are dropping as the highest-paid sectors shrink, in the case of Wall St perhaps for a long time. Construction costs will drop as the economy slows. Case-Shiller, out today, shows NY metro area one-families accelerating in price decline and still wildly too high. All the trend lines are heading in the same direction with no inflection points visible.

Expect further price declines. Expect declines to make further declines more likely. Don't expect any reversal of direction in NYC until it is clear what form the financial industries will take after recovery and whether the new institutions will be in NY.

Expect a bottom at rational pricing: when you can buy a house for cash, rent it out, and earn significantly more from rents (after deducting all costs, including your own labor and real maintenance/repair costs, and assuming that the price of land remains stable) than the bank expects to make on a mortgage where it -- not the government -- is taking the risk of default (look at the rates they charge for unsecuritized jumbos, not the rate for FNMA loans). The homeowner's risk is higher than the bank's and homeowners aren't going to be bailed out, so in rational markets, homeowners should earn more than the bank. If that price is higher than the cost of renovation, new construction or evicting rent stabilized tenants, assume that the market will stabilize at the lowest number (and that land prices will drop as much as necessary).

But don't count on rational pricing: there is no guarantee prices won't go lower still, especially if investors are worried about future rent decreases, slower subways, Wall Street's short-termers overpowering Washington, or other investors losing heart.

Posted by: FinanceGuy at March 31, 2009 11:30 AM in response to Getting a Jump on the Q1 Post-Mortems

Benson:

1. Improvements, renovation. This is a real issue. Clearly, part of the aggregate rise has to be improvements in the housing stock; the question is how much. Nationally, we have reasonable statistics: the total amount spent on improvements is something like 10% of the price rise. So nationally, we know that isn't a big part of the bubble.

Locally, we don't have any good detailed statistics to start with. But there is no evidence I know of suggesting that NYC has had proportionally more renovation than the rest of the country.

Absent better info, I think the best way to adjust is to compare comparable rentals to sales. If you use comparable rentals, you are already adjusting for changes in quality.

2.Comparing to the rental market. One of the strongest indicators of the bubble is that **market** rents have followed inflation (with some minor variation--e.g. Ft Greene--to reflect quality changes), as we'd expect, but ownership costs have gone up much faster.

It is hard to get any more specific than this using aggregate numbers; mostly the numbers you'd want don't exist.

So I'm suggesting a "retail" level comparison: ask yourself what the particular place you are looking at would rent for and then compare.

Would a long term investor, expecting to be paid for work and risk (including downpayment), be willing to buy this place if he/she/it expected to get this rent and have these expenses -- without taking into account the possibility of selling it to someone who isn't making this calculation. That'll give you the equilibrium price.

3. Rent stabilization. Rent stabilization probably makes the (market) rental/sale comparison work better in NY than elsewhere. In other parts of the country, it is hard to find quality rentals, so the upper middle class is forced to buy. Here, stabilization increases both demand and supply. Stabilization makes renting safer and therefore more attractive for long term tenants with choices. This pool of affluent tenants makes it more attractive for landlords to provide "luxury" rentals. Moreover, new construction/major renovations usually start at market, so if stabilization actually keeps rents below market (evidence suggests it does NOT, except in relatively short periods), it would also make creating new rentals more profitable.

The upshot is that NYC, unusually, has a vibrant rental market in all sectors. So you don't need to adjust as much for the thinness of the upper end of the rental market. (I usually do anyway: I'm more sure what the rental value is of a floor-through in any given condition/neighborhood than of a full house, so I usually use the floor through value multiplied by the number of floors rather than trying to guess what the rent would be for a big unit.)

The more developed upperclass rental market also means that imbalances are less likely to last forever: even people who "have" to live in a newly renovated mansion can rent if the prices get too out of whack.

4. Monster bubbles. This is a monster bubble by any measure -- one of the biggest in Shiller's data. We won't imitate Tokyo and London slavishly; they just demonstrate that big bubbles are followed by big pops. Which we could figure out anyway.

5. Bubbles and high incomes. Wall St had unprecedentedly large income and also made credit unprecedentedly available to the next rungs down, and this provided the fuel for the bubble. Those fuels are gone or at least reduced.

But the bubble would have collapsed anyway; bubbles always do.

Bubbles happen when people are willing to overpay because they think the next person will overpay even more. At some point, though, the bigger fools wise up. Then the psychology changes. All of a sudden, you have to make money without selling -- and you can't at bubble prices, so prices have to come down.

Bubble prices didn't rise because there were a lot of rich people around. They rose because people thought that spending more money on houses was the surest way to GET rich. It looked like a free lunch: the more you pay, the more you make. Pay extra to live in a good school district and make more money as a result. Live well AND get rich too. Well, not exactly free lunch. More like free banquet.

Now that they see that spending too much on houses is likely to make them poorer, they won't be willing to spend as much. Even really rich people (ESPECIALLY really rich people) don't like to throw away their money.

If they also CAN'T spend, because income and credit are dropping, that's just icing on the cake.

6. Case Shiller. Case Shiller tracks the entire metro area, including vast stretches of the 'burbs, and only tracks comparable sales of single family houses, so it is only a rough indicator of the brownstone market. Furman uses more or less the same methodology, but limits to NYC. Interestingly, the two show roughly consistent results, suggesting that NYC and brownstones actually are not separate markets from the region and the country. Both indexes attempt to control for renovations by excluding houses with the biggest prices jumps, but clearly that is pretty crude.

7. Rent/own ratios. Case Shiller don't compare rents to housing prices, although other academics have, using national numbers.

The academic studies usually compare **median** rentals to **median** sales. They do this because the numbers exist, not because they think they are comparable. In most of the country, there is no high end rental market, so median rentals reflect lower quality units than median sales. That's why the national studies report historic rent-own ratios in the range of 15 times annual rents. For a comparable unit, that's way too high -- any investor buying at that price would lose money.

NYC rental mix is different, and I haven't seen an aggregate study comparing NYC rents to ownership costs on a historical basis.

The 8-10 times annual rents number I use is NOT based on good statistics. Instead, it is anecdote and

Posted by: FinanceGuy at March 13, 2009 11:39 AM in response to Furman Center's State of the City Report: Brooklyn

1. Re location, public schools, urbanization and all that -- that's why I like the rental comparison: if those things actually lead to some scarcity value (above the cost of construction-not land), they'll be picked up in rent. There is no particular reason why any of those factors should affect sales price but not rent.

2. Re comparing rent to sales. As Chicken notes, it isn't fair to compare your monthly costs to rent without also including (1) the downpayment, and (2) the tax deduction. The downpayment costs money. The owner is taking a bigger risk than the mortgage bank, so the downpayment should be earning more than the mortgage.

To compare to rents, you need to include all the costs of ownership -- mortgage interest (not principal), taxes, heat, insurance, repairs & maintenance AND implicit interest on your downpayment, using a rate at least as high as the mortgage interest rate. Then, reduce this by the tax subsidy (not the entire deduction, but the amount of taxes it saves you).

3. What interest rate to use. Chicken is right that the calculation is sensitive to interest rates. If you are trying to determine whether prices are reasonable now, then you need to use the rates now.

But you may want to use a somewhat higher rate to protect yourself against the snap-back problem: current rates are obviously unusually low, and it is safe to assume they will be higher when you sell (which will make your equilibrium sale price lower).

4. This is an analysis of equilibrium prices. Markets, even more efficient ones than NY real estate, don't spend much time at equilibrium.

The real estate bubble was obvious in 2002, but it kept growing for another 4 or 5 years. If you invested in 2002 assuming that prices would return to equilibrium you would have had a long period of misery and a lot of "bitter renter" taunts -- and you'd still be way behind the bubble's true believers.

There is no guarantee that prices will drop to fair value this year. Or that prices will stop dropping when they reach equilibrium.

5. Real numbers -- You can plug in your own numbers, and if they show that we are at equilibrium, you should assume that drops below that will probably correct in the not too distant future. If the same is true nationally, that also would imply that the current crisis is just a liquidity crisis or a panic and that the bank rescue should end up costing the taxpayers nothing at all.

But using the returns real estate investors usually demand, $2500 for a floor-through rental -- is that still a reasonable Park Slope rent for a nice 800 sft place? -- implies an equilibrium purchase value of around $1.25m (~$400/sft) for a four story brownstone in similar condition and location. I'm not seeing that.

6. Comparing to construction costs. I meant construction costs, not land. Land is circular: in a bubble market, the price of land goes up because buyers expect to be able to sell the house for more. To then say the house is worth more because the land costs more is a perpetual motion machine. That's the kind of magic thinking that caused this disaster in the first place.

Posted by: FinanceGuy at March 13, 2009 12:18 AM in response to Furman Center's State of the City Report: Brooklyn

11217 re NY income: I don't think so. The increases in base salaries are likely to be far less than the decreases in bonuses. And in any event, the number of highly paid jobs is contracting rather significantly.

Posted by: FinanceGuy at March 12, 2009 1:41 PM in response to Furman Center's State of the City Report: Brooklyn

Benson:

Shiller's data does not show real estate prices tracking "income". Long run, prices don't exceed inflation (because if run higher than replacement cost, supply starts to increase and bring them down again).

In growing economies, income goes up faster than inflation (well, not for middle income Americans in the last generation, but in more successful economies).

And the key problem in NYC is NOT the recession. The key problem is the bubble that preceded the recession. We need a massive price drop to get back to equilibrium if there are NO job losses.

The Japanese had a similar sized bubble and when it popped prices went down far more than 50%.

11217: Wall Street's recent profits, and pay, are unprecedented. Finance rose from 10% of the economy to 30% in barely a decade. It may come back, but it's not because it "always does": we've never been here before.

Posted by: FinanceGuy at March 12, 2009 1:35 PM in response to Furman Center's State of the City Report: Brooklyn

11217 -- NY's economy is likely to "recover".

But NY real estate prices are unlikely to "recover," because "recovery" implies that they were correct before and are wrong now.

The reality is that they were (and are) completely irrational. So "recovery" means that they will drop dramatically.

In a market economy, the equilibrium price of a commodity should be equal to (1) the marginal cost to produce it (i.e., the cheapest of the cost of construction or conversion) and (2) the marginal cost of alternatives (i.e., renting) and (3) for investments, the risk-adjusted future value of the income that can be earned from it (i.e., rents, or for owner occupied housing, implicit rents).

Each of those measures suggests that NY real estate prices are roughly double equilibrium values.

Posted by: FinanceGuy at March 12, 2009 1:15 PM in response to Furman Center's State of the City Report: Brooklyn

Benson--the Furman index is inflation adjusted. 4.5% over inflation is completely unprecedented and unsustainable. Shiller shows, and normal market logic demands, that in the long run housing prices do not increase faster than inflation.

So the Furman index implies that current prices are 2.5 times too high -- they'll need to drop more than 50% to revert to trend.

This is may be somewhat overstated, since the base year was a bad year for the City generally. Still, there is nothing in this report to contradict the theory that NYC participated fully in the real estate bubble and that we should expect its prices to drop proportionately.

The easiest way to estimate non-bubble prices while taking into account the improvements in quality of life in NY is to start with rental values. Rentals are less susceptible to bubbles, since people are less willing to pay more to rent today just because they think that rents will be higher tomorrow.

Historically (i.e., before 2001), NYC real estate prices have run about 8-10 times annual rents. That's enough for an investor to earn a reasonable return -- slightly more than mortgage rates -- for the risk and work involved. It also means that homeowners, who take a huge risk by concentrating all their net worth in a single asset, are slightly compensated for the risk they take: at those ratios, it is slightly cheaper to own than rent, taking into account the tax subsidy and the fact that downpayments and maintenance are not free.

If prices are higher than this, there is a strong incentive for investors to convert rentals to owner-occupied and/or to build, so normal supply and demand should -- over periods of several years -- tend to prevent prices staying above this level.

Based on casual observation of rents in the area, it looks to me like the prime areas still have a long way to drop, even if rents don't drop further. Some of the outlying areas may be getting closer to trend (which doesn't mean they won't overshoot on the way down).

Posted by: FinanceGuy at March 12, 2009 12:59 PM in response to Furman Center's State of the City Report: Brooklyn

Ok, let's hear the explanation of that one.

1. In Econ 101 as I learned it, rising interest rates mean that the price of income producing assets goes down. Real estate is a income producing asset. Why invest in real estate, which is risky and hard work, if you can make more money holding a less risky and less work-intensive bond? Higher interest rates don't seem very likely in the near term, but when they come, they'll make real estate prices go DOWN, not up.

2. Rising interest rates mean that the cost of owning goes up. That makes owning more expensive relative to renting. For both reasons demand goes down. In Econ 101 as I learned it, when effective demand drops, prices go down not up.

4. More fundamentally, the basic point on Econ 101 is that markets tend to converge to the point where price equals cost, because if prices are higher than that, excess profit can be made by creating more supply. And -- surprise -- high prices in Brownstone Brooklyn have led to an explosion in conversions, in-fill, expansion of boundaries, etc. In Econ 101, more supply and reduced demand means prices go down, to no more than costs.

5. Macro econ is usually Econ 102, but here too DIBS needs to explain a bit. From here it looks like we are in a period of DEflation, not INflation. Credit is contracting, jobs are contracting, demand is contracting, real estate prices are dropping, rents are dropping, interest rates are at historic lows, and the government stimulus efforts are expected to replace less than 1/3 the lost demand in the private sector. Most important for upper class NY housing, Wall St pay is shrinking. Why is this a period of "rising inflation and rising interest rates"?

6. Even with inflation (which isn't happening), rent increases (which aren't happening), loose credit (which isn't happening despite the government's best efforts), further improvements in quality of life in NYC (not likely if the City's fiscal crisis doesn't magically self-correct) no increases in supply (i.e., no development, no expansion of acceptable borders for middle-class buyers), and no drop in demand (yeah, right) -- prices still have a long way to go down.

Unless upper middle class/professional/jr banker pay suddenly jumps, BHO is an optimist. Half off peak would barely get us back to trend; markets usually overshoot.

Posted by: FinanceGuy at February 9, 2009 6:02 PM in response to Tales from Florida

DIBS, if you calculate your opportunity cost as the S&P500's returns for the last year, you made a fortune on your house.

Congratulations! At that rate, you'll be even richer than my girlfriend got shopping at the Bloomingdale's 50% off sale.
If she had only spent a bit more, she'd have saved so much I could retire right now.

Posted by: FinanceGuy at January 15, 2009 4:24 PM in response to Supply and Demand Falling in Lockstep

Econ 101: "most" (potential) sellers are irrelevant. The price is determined at the margin: the most desperate seller makes a deal with the most spendthrift buyer.

In rational markets, buyers expect to be paid for the risk and hassle of homeowership, so prices drop until it is slightly cheaper to buy than to rent (enough cheaper that investors can make an immediate profit renting, even if they honestly account for their time, opportunity costs and maintenance expenses).

In bubble markets like the one just ending, buyers will pay silly prices because they plan to sell at even sillier prices. Banks become enablers, on the same theory: they don't care if the buyer is overpaying or over-borrowing, because if the borrower can't pay, he/she will just sell to an even sillier buyer. But when the bubble ends, those buyers and those banks rapidly disappear.

In declining markets, the bubble logic can work in reverse: you'd be crazy to pay full value (let alone double value) today when it is going to be cheaper tomorrow. So the market is just as likely to overshoot on the way down as on the way up. At some previous NY bottoms, it cost half as much to buy as to rent.

Transactions are dropping because sellers are attempting to demand more than the market clearing price. In effect, we have a sellers' cartel. However, Econ 101 predicts that cartels usually fail. Especially when the only coordinator and enforcer of the cartel is real estate agents.

Sale price drops are now inevitable unless Obama decides to hand the entire stimulus package, no strings attached, to Manhattan investment bankers.

If you are willing to pay double fair value based on current rents -- you should first ask yourself whether your seller is really the best object of your charity. Wouldn't it be better to just give away half your money to someone deserving, and then wait 6 months to buy?

Posted by: FinanceGuy at January 15, 2009 4:11 PM in response to Supply and Demand Falling in Lockstep

Econ 101 says that demand and supply (which is quite different from inventory, of course) converge at the point where price equals marginal cost of production.

The marginal cost of production of a Brooklyn brownstone is the lowest of: (1) construction cost for a new unit that might appeal to the least committed brownstoner, (2) cost to convert an existing rental to owner-occupancy, or (3) cost to renovate a substandard unit to current expectations.

Moreover, Econ 101 predicts that rental values and home prices will converge (if they differ, developers will assiduously work to convert the cheaper form into the more expensive one.

Rental values are about half current asking prices, at least if the Love Lane house is any indication.

If you believe that current sale prices are stable, you should also expect that rents are likely to double in the near future. If you believe that current rents are likely to drop as unemployment rises and incomes drop, then you should anticipate huge reductions in sales prices.

If you reject both these possibilities, you must believe that Econ 101 doesn't apply to NYC for some reason.

Posted by: FinanceGuy at January 15, 2009 11:23 AM in response to Supply and Demand Falling in Lockstep

15x annual rents is too high. That number comes from studies comparing median sales to median rents in parts of the country where the median owner occupied house is of considerably better quality than the median rental property.

In NYC, unlike most of the country, units of every quality level exist both as rentals and as sales, so the national number is inappropriate.

Comparing comparable units, the NYC ratio, pre-bubble, usually was in the range of 8-10 x annual rents (except in the really bad years, when it went lower, based on expectations that rents would not keep up with inflation). This number makes sense, since it is rarely possible for a long-term investor to make money renting (and maintaining) a building if they pay more than that. And in rational markets, owner-occupants do not pay more than investors, if for no other reason than owner-occupants, as a rule, are less diversified and therefore taking a bigger risk.

So if $9500 is a fair rental, the fair sales price for this home should be no more than $1.15m. Or, alternatively, if $2.5m is a fair sales price, it should be rentable for $20,000 per month -- that's about the real cost, including maintenance & taxes, opportunity cost on the downpayment, and mortgage, of buying it.

Posted by: FinanceGuy at January 15, 2009 12:10 AM in response to No Takers, 43 Love Lane Now For Rent As Well

Correction: I wrote "relative to inflation", but I meant valuation levels, meaning prices relative to fundamentals (rental value, buyer's income, reproduction costs) -- are remarkably consistent.

Although Shiller does also show that real estate prices in large important cities basically don't go up much more than inflation.

Posted by: FinanceGuy at January 9, 2009 10:15 AM in response to Goldman: NYC Prices Have a Ways to Go

DIBS: Probably about the same amount, inflation adjusted. Valuation levels -- prices relative to inflation -- are remarkably consistent over extremely long periods of time, as Prof. Shiller has shown.

NYC housing sold for between 10-12x annual rental value for most of the last century (not surprisingly, since at higher sales prices there is a tremendous economic incentive to convert rentals into sales).

Both rents and purchase prices went up pretty consistently at the same rate as income (not surprisingly, since if they went up faster, there quickly wouldn't be anyone able to pay them).

The last several years really were different. A dramatic change in the credit markets allowed people to borrow unprecedentedly large amounts relative to income while simultaneously giving people in the credit and related businesses unprecedentedly large incomes. That's over, at least for now.

Posted by: FinanceGuy at January 9, 2009 10:02 AM in response to Goldman: NYC Prices Have a Ways to Go

Dave, that's wild. Do you really believe markets are entirely disconnected from each other?

Every apartment sold to a super-rich person paying bubble prices resulted in a seller sitting on a sudden windfall which they could use to buy another apartment or house. Some added borrowing and moved up; others reduced borrowing and moved down or out. Each one of those moves made it possible for someone else to sell into the bubble, so in the end, every ultra-rich purchase finances several other more normal ones. You ought to know this -- didn't you yourself pay for your Brooklyn home by selling a Manhattan apartment into the bubble?

In NYC, this trickle-downn financed the bubble at least as much as trickle-up from middle-class buyers able to access securitized mortgages to overextend themselves.

Now, the music has stopped for both these games.

Posted by: FinanceGuy at December 19, 2008 11:48 AM in response to The Madoff Mess and Real Estate

bxgirl: Of course rents go up when neighborhoods get trendy. Fashion is a real -- current -- improvement in quality of life for many people.

The difference between rents and sales, though, is that it is rare that renters are willing to pay more today because they think that rents are going to go up next year. Buyers, in contrast, often do that (or the reverse).

In the last several years NY prices went up because crime went down and BK became fashionable and people realized that cities are good places to live -- that's all reflected in the rents.

But PURCHASE prices also went up because people wanted to get in now before prices went up more. That's a bubble: people paying more than they think the place is worth (to rent or live in) because they think they'll be able to sell it to someone else for even more (or they'll have to overpay even more if they wait). It leads to completely irrational prices. Eventually, though, somewhere around $3m for a Carroll Gardens special, even the irrationality ends, usually because the banks decide to stop financing.

(Bubbles can work in the other direction, as in the white flight years, when people sold at silly prices because they feared they'd get even sillier -- eventually driving prices so low that in the late 60's the City was paying people to take Upper West Side brownstones off their hands.)

We are at the end of the biggest bubble in US history. If you want to get an idea of where prices are likely to go, you need to look at something that is unaffected by the bubble. Rents are much less likely to be based on speculation about where rents are going, and much more likely to be based on how much people are making and how much they actually want to live in the neighborhood/apt right now.

Posted by: FinanceGuy at December 14, 2008 11:13 PM in response to Home Ownership Bad for Your Health

Why use rents rather than sales comps?

Sales prices can easily get out of whack if buyers are willing to overpay now because they think, like Sebb, that there is some guarantee that they can sell for more later, or, for that matter, if sellers are willing to sell for discount prices because they think, like Bob Marvin's friends in the white flight generation, that there will be no one to buy from them later. Bubbles and panics happen when the prices people are willing to pay now are based on their views about the prices someone else will be willing to pay later, which are based on the same thing. In that sort of market, any price is possible, at least for a while.

Since renters are paying current prices for current services, not speculating on the future, rents are much more tied to real factors like actual quality of life right now, current incomes, transportation, fashions, lifestyles, crime rates, and so on.

So if you want to separate out the bubble irrationality from the real improvements in NYC, look at (non-stabilized) rents. They've gone up quite a bit as neighborhoods have improved, but nothing like prices in the last decade.

Posted by: FinanceGuy at December 13, 2008 9:29 AM in response to Home Ownership Bad for Your Health

Bob Marvin, by not thinking like an investor, did exactly what good investors do: he bought at the bottom. When everyone thinks the market can do nothing but go down, all news is likely to be good.

Today, though, the prices assume that all future news is going to be good -- the sellers expect to be paid for improvements in the neighborhoods that haven't even happened yet. That means that all future news is almost automatically going to be bad: it would be basically impossible for the world to turn out as good as current prices assume. So people who want to imitate Bob Marvin should probably be looking in Lodi NJ or Sebb's Staten Island, or some other place that nobody thinks can make it. Not in Park Slope.

Mopar --
1. By rental value, I mean the price that a rational investor would pay for the house to hold it as a rental property, assuming that returns will come from rents, not from flipping the property.

2. Interest is gone. It belongs to the bank. You don't get it back. What you get, if you get anything, is the equity you put into the house (downpayment plus the part of the mortgage payment that isn't interest) plus or minus any change in the value of the house. Whether that will be profitable or not depends on how much you pay and what happens to prices.

If you pay 2x the rental value, it is hard to see how prices can keep going up unless rents suddenly start exploding. And rents can't go up faster than incomes except in very short term, because people have to be able to pay them. So it seems unlikely that rents are quickly going to go up enough to justify current prices.

3. For most of the last 75 years, NYC buyers could project making 8-10% returns on their equity investment from rents alone assuming that rents would rise no faster than expenses and there would be no price appreciation. (Owner occupants made a bit more, if they did the calculation as if they were paying themselves rent at the market rate, because of the tax subsidies). Without knowing where Bob Marvin lives or when he bought, I'm willing to bet that if he can reconstruct what market rents were when he bought, he'll confirm this. It was true everywhere in NYC from at least the 1940s until 10 years ago, with only the slightest exception at the top of the late 1980s boom.

Today, if you are finding those kinds of prices, you are looking in different neighborhoods than I am or you are looking harder. The prices I'm seeing are double that. But I have no special information about prices. Maybe there are deals out there that don't show up in HOTD or maybe I'm underestimating rents. Or maybe the correction is further along where you are looking.

4. Scholars using national figures generally show lower expected returns (purchase prices are higher relative to rental values) than I am think have been true in NYC. Usually they find historic values that are around 15x annual rents, which means profit rates of under 6% rather than 8-10%. That rate seems implausibly low to me -- it doesn't make sense that equity owners should be willing to invest for less than the bank takes. So I think something is wrong in their numbers -- most likely that in most of the country, rental property is significantly lower in quality than purchase property and it is hard for investigators to correct for this. So they are not really comparing comparables -- they are comparing nicer owner-occupied stuff to not-so-nice rentals.

In NYC, in contrast, the rental market is large, liquid, and in all price ranges, and I think that it is possible to have a pretty good idea of what the real rental values are even for nice apartments (with the possible exception of the Jennifer Connolly mansion). There are plenty of garden floor-throughs that are in the same condition as the upstairs unit, and it isn't hard to simply multiply the floor-through rent by 2 or 3 to get an estimate of the rental value of the duplex or triplex.

Since it is relatively easy (in Brownstone Brooklyn) to convert owner-occupied to rental, to change configurations, and even not impossible to change rentals to owner-occupied, normal market forces should keep all these prices pretty similar. If a building is more profitable in one form than the other, someone is likely to change it to the more profitable form -- which has the effect of driving the prices back together.

Right now we have a major imbalance, as I read the market: owner occupants are paying way more than renters. So there is lots of profit to be made converting rentals into sales. Eventually, this will mean either that rents go up or sales prices go down -- and my guess is that it's going to be sales prices coming down.

Posted by: FinanceGuy at December 13, 2008 9:29 AM in response to Home Ownership Bad for Your Health

Mopar:

1. Interest is exactly as gone as rent. Interest is just the rent you pay for money. The only difference is that when you rent a home instead of renting money, the landlord is legally obliged to pay for repairs, taxes, heat, water/sewer and insurance.

2. Whenever you buy a highly leveraged investment you make a lot of money if prices go up. But as Lehman learned to our regret, if prices go down, you lose a lot, too.

When you sell you make money IF prices have gone up. If you bought in SF at the peak, you've lost all your equity now. And remember that running a house is quite expensive -- it isn't just the purchase cost and interest.

People who bought 20 or 30 years ago didn't overpay. There is no reason to think that if you pay 2x fair value you are going to have the same result as people who paid 3/4 fair value and sold into the biggest housing bubble in history. We can all envy the people who by luck or skill made a fortune in real estate in the last generation, but to think that we will get the same result now is just dumb.

3. Retirement costs are never fixed. If you don't have a lot of money, or live in a country with a civilized retirement system (which would be essentially every advanced democracy but our own), you are screwed. Investing in real estate can be a good way to deal with this problem as an individual, if you have enough money to make the investment in the first place and if you don't overpay. Otherwise, not.

Posted by: FinanceGuy at December 12, 2008 4:16 PM in response to Home Ownership Bad for Your Health

For the people making broad generalizations about retirement -- the point is that if you are thinking of your house as an investment you need to treat it like an investment.

Bob Marvin bought his house in the '70s, I gather. That was a good investment (stocks would have been good too then). If you had done my calculation then, you would have seen that owners were being paid good money to take on the risk of ownership.

But if you buy now in the prime neighborhoods, you are paying double fair value. Tax breaks are nice, but they are far too small to affect the basic math. If you pay double rental value, you are never going to catch up to the renter who invests in almost anything else. The point is that this is an awful investment: the anticipated returns are negative as far as you can see.

If you are incapable of saving and/or investing except by having a mortgage, it might make sense to pay something for the privilege of having someone force you to save a little bit. But most employers will create a tax sheltered forced savings plan for you (they call it a 401(k)) for free. You don't need to give up 20 years of appreciation for that.

Posted by: FinanceGuy at December 12, 2008 4:01 PM in response to Home Ownership Bad for Your Health

parkedslope & benson: I agree that it is nicer to live close in, with good transit, etc. But that is the beauty of the rental/buy comparison. The benefits of the neighborhood are all picked up in the rents, aren't they?

For the "zoned land" meme to justify bubble prices, you need not just a premium for better location, but an ever-growing premium compared to rents and the competition. That isn't going to happen. Brooklyn Heights will always be more expensive than Bay Ridge, but there is a limit to how big the gap can get.

When it gets too big, the market increases supply: DUMBO/Furman St/110 Livingston/Hotel St George/Mason Mints/etc, for all their industrial wasteland aspects, have effectively doubled the size of Brooklyn Heights; Cobble Hill and Carroll Gardens have swallowed half of Gowanus/Red Hook; Park Slope is at least twice as big as it was in 1990; the Flatbush Avenue color bar fell to a combination of diminished racism and price increases; "gentrifiers" live in places they wouldn't have dreamed of a few years ago.

Parkedslope -- I wasn't advocating pushing people out. Just stating the reality: that if the financial incentives are big enough, they'll get pushed out. My parents were. That's been the history of NYC as long as I can remember. Do you think it is going to stop?

As long as owner occupants are willing to pay 2x the rental value, someone is going to see an opportunity to double their money by buying rentals and kicking people out. It doesn't really matter whether I like it. The only thing that will stop it, absent a political movement and legal change that I would welcome but see no sign of, is when rental values and ownership prices converge.

After taxes of course, but capital gains taxes are so low and so easy to avoid that they don't make much difference -- certainly saving 15% taxes 30 years from now isn't a reason to pay double today.

Posted by: FinanceGuy at December 12, 2008 3:51 PM in response to Home Ownership Bad for Your Health

Adam -- so no fixed rates at all? And 30% downpayment in addition to 25% reserves (so less than half financed)?

Posted by: FinanceGuy at December 12, 2008 3:13 PM in response to Jumbo Mortgages?

Benson: this is the "zoned world" meme. It hasn't worked in the rest of the zoned land: prices got too high and they are coming down.

Zoning is important, but it isn't all that hard to create more land in NYC. You just build up (as in 4th Ave or all of Manhattan), convert industrial property (DUMBO, Gowanus), evict rent stabilized tenants (everywhere), renovate old stuff (Brownstone Brooklyn), convince people that they can go beyond the old boundaries (I remember when Baltic St & Clinton St was the wilderness -- way beyond anywhere respectable people would go), build infill.

There are probably 10x as many luxury housing units in NYC as 25 years ago. I don't think that the number of people who can afford them has gone up nearly that fast.

Posted by: FinanceGuy at December 12, 2008 2:13 PM in response to Home Ownership Bad for Your Health

On taxes and insurance. Yes, I should have included taxes (pro-ownership) and insurance (pro-renting). I did assume that renters can find comparable properties, which usually has been more or less possible in Brownstone Brooklyn except perhaps at the very highest end (Remsen St mansions). If rental properties are all in worse shape than owner-occupied, then you need to adjust for that (pro-ownership). I also almost certainly underestimated repair costs, especially for homeowners who don't enjoy doing repairs (pro-renting). And 8% is a very low rate of return for investors in a highly concentrated, high risk, high work investment in a bubble that is only partly deflated. Don't you think you should make **more** than the bank? (pro-renting)

On taxes, interest is deductible on a mortgage for up to $1m. For buyers in the prime NY markets, paying the highest tax rates, this could be worth as much as $2000 per month. Assuming that the entire benefit goes to the seller and not the buyer (historically, in NYC, the reverse was the case), that could justify adding an additional 300k to the prices I quoted.

But at current prices, there is no point trying to get all these details accurate.

The reality is that unless I'm way off in my rental estimates, current sales prices in the prime neighborhoods are way, way too high. Exactly how too high depends partly on rents and largely on whether the banks figure out a new way to avoid default risk or whether they decide that they are going to be holding the bag and therefore they need to be sure that the collateral (house) is really going to be saleable in a foreclosure for the appraised value.

If you buy at current prices, you are making a very large bet that banks will be willing to lend -- even after the crisis is over -- based on bubble values that have no relationship to investment or replacement costs or foreclosure prices.

You are also betting against the normal workings of capitalism. If houses are selling at two or three times the cost of creating them, someone is going to figure out a way of making more (e.g.: expanding the acceptable boundaries of the "nice" neighborhoods, converting rentals/warehouses into brownstone equivalents, renovating substandard houses, new construction). Sooner or later, supply will expand to meet demand and the market clearing price will reflect the actual costs of construction. That's why appraisers rely on construction costs as a ceiling and rental values as a floor for fair value in non-bubble markets.

If I were a buyer, I'd wait, unless the right to renovate is very valuable. If I were a seller, I'd sell before the market corrects more.

Posted by: FinanceGuy at December 12, 2008 2:05 PM in response to Home Ownership Bad for Your Health

This is Baltic Street, not Brooklyn Heights. The rental value of this place is probably $12k /month ($3000 per floor).

That means that an investor hoping to make 8% wouldn't pay more than $1.5m assuming no further effects of the recession.

Looked at another way, 4500 ft x $300 psf = $1.35m replacement cost.

These are two of the three methods bank appraisers are required to use, and increasingly they are going to be the key ones to determine what the banks are willing to lend. (The third one, comparative sales, is useless, since the comps are all based on unsustainable bubble prices). With bank appraisals coming in at these numbers, how long will it take before buyers are neither willing nor able to go much higher?

If my rental or construction cost guesses are right, anything over $1.5m is either pure bubble speculation (it's ok to overpay, because someone else will overpay even more next year even without bank help), or based on a strange belief that rents are about to soar, or pure consumption -- like buying an expensive car knowing that it will be worthless in a few years.

If I'm wrong about rents or replacement cost, give me more realistic numbers. The asking price implies a rental value of about $28k/month, which seems ludicrous to me.

Posted by: FinanceGuy at December 12, 2008 11:19 AM in response to House of the Day: 167 Baltic Street

I haven't found anyone willing to do a HELOC to let me keep the main mortgage below the conforming.

Over $1m, the quotes I'm getting on a 30 year fixed at par are about 8%, with at least 30% downpayment. Over $1.5m the rates go up again.

If anyone is offering better than that, I'd love to hear about it.

Posted by: FinanceGuy at December 12, 2008 11:01 AM in response to Jumbo Mortgages?

The economics of renting v homeownership are pretty simple.

Renting you pay $x per month, in return for which you get a home and some repair services.

Owning, you pay $y per month for taxes and utilities (that are included in the renters rent). You pay $z in interest (which is just as gone as rent). If you have equity, you have some money that could be earning interest if it were invested elsewhere -- that is another expense (an opportunity cost) that is just like interest. If you are calculating rationally, you should give this a value based on the alternatives you have, and it should be higher than the interest rate on your mortgage (since it is riskier). And you pay (or do) repairs and maintenance, which the renter would have included in rent.

All these are monthly expenses just like rent. Add them all up. So far, if they are lower than rent, you are better off owning. If they are higher than rent, you are better off renting.

Then, there are two additional factors, one financial and one not. One is control-the right to exercise your personal bad taste in renovating. Hard to put a price on that.

The other is future appreciation/depreciation. Owners have the risk (up and down) of future price changes; renters do their investing outside their homes. Most owners are highly leveraged (that is, they have big mortgages), which means that they will make a lot if housing prices go up and lose a lot if they go down. If you buy with a 20% downpayment, and prices drop 20%, you've lost your entire downpayment. If they go up 20$, you've doubled your downpayment. So in rising markets, owners make a lot, and in declining ones, they lose a lot.

Shiller has done research on long term price trends. Over long term, even in elite cities housing prices tend to reflect cost of construction (not land) rather precisely. That is, they go up more or less with inflation.

Right now, we are coming off of the largest housing bubble in US history; NYC prices are roughly double the trend values. It is a safe bet that over the next few years they will return to trend -- that is, drop about half in real terms (probably less in dollars, since inflation will do some of the work). Banks are not entirely dumb; assuming that they are now going to have to keep the risk of jumbo mortgages, they are going to build this expected depreciation into their loan decisions, which will make it even more likely to happen.

Moreover, mortgage rates (at least for conforming loans) are very low. When they rise to more normal levels (which will be higher than in the bubble days of CMOs), house prices will have to drop to compensate.

For both these reasons, buyers should be planning on price depreciation over the next several years, and little (real) appreciation after that (unless mortgage interest rates go below inflation). So even if your monthly costs (including the lost interest on your downpayment and the time you spend in maintenance) are less than rent, you still may be financially better off renting.

The economic way to think about appreciation/depreciation is to decide whether you think buying highly leveraged NYC real estate is a better investment than the alternatives you have. There is nothing magic about "paying off the mortgage and living rent free": it isn't free, and if you rented and invested successfully, you'd be able to live work-free too. The only issue is whether this is the best investment you have. (In rising markets, for small investors, it usually is: it forces you to save, and it is the only convenient way to use leverage, two things that amplify returns on the way up.)

Posted by: FinanceGuy at December 12, 2008 10:58 AM in response to Home Ownership Bad for Your Health

Iron Balls -- who were you working with? Were you happy with them? Was your mortgage over $1m? I haven't found any rate close to that.

Posted by: FinanceGuy at December 11, 2008 10:21 PM in response to Jumbo Mortgages?

The Case-Shiller index shows SF and NYC going up in almost precisely lockstep. Going down, however, SF is well ahead of NYC. The only reason "SF is comparing very unfavorably to NYC in the Case-Schiller index" is that the NYC market is still in dream-land.

Posted by: FinanceGuy at October 2, 2008 1:45 PM in response to Brooklyn Manhattan's St. Paul, Not Compton

The financial industries are not being brought down by "irrational" panic, but by their own terrible investments, which have left them insolvent.

If you lend money to people who have no reasonable expectation of paying it back except by selling overpriced real estate to other people for even higher prices, and then take the loans and shuffle them around to investors who don't understand what stands behind them, sooner or later there is going to be a problem.

Our bad luck is that it was later, so the problem is quite large. Someone, presumably US taxpayers or our lenders (i.e., the Chinese), is going to have to pay $1-3 trillion to repair the damage they've done.

NY incomes are going to drop faster than in the rest of the country, since more of them are directly or indirectly tied to the recently deceased business model. In a rational market, which this has not been for the last 6-8 years, that would lead to a sharp and dramatic real estate price drop, even if prices were not bubble-inflated to begin with.

If I remember correctly, in Tokyo's bubble bursting, real estate values dropped 85%. Our bubble is by most measures no smaller.

Posted by: FinanceGuy at September 22, 2008 11:29 PM in response to What Lies Beneath?

Uh... this price is incredibly high by any realistic valuation method. Does anyone seriously believe that it would cost $15k/month to rent a comparable place, or that it would be impossible to build similar sized and quality housing for this price, or that the normal rules of the market have been repealed? The bubble still has a long way to deflate.

If this sale is indicative, the adjustment looks like its going to happen the same way as after the (much smaller) late 80's bubble: by relatively flat nominal prices until real prices drop back to trend. That route, with current inflation, implies a flat or slowly declining (in nominal terms) market for the next decade.

Unless, of course, enough sellers get tired of waiting or want to go on with their lives or lose the jobs that were paying the mortgage. This market is so small that it wouldn't take many sellers who don't want to wait a year to change the tenor quite quickly.

Posted by: FinanceGuy at August 24, 2008 9:02 AM in response to Sales: 146 Sterling Place Fetches $2,730,000

At 6.5% without PMI, this is indeed getting close to rental value (although not as close as McFly or 11217 calculate, because they are treating the downpayment as free, which is silly).

Not going to make you rich, but if you can hold on through the downturn of the next few years, you won't be far behind the renters, either.

And in the meantime, you can struggle with the moral dilemmas of renovation...

Posted by: FinanceGuy at August 20, 2008 6:36 PM in response to Co-op of the Day: 123 Henry Street

Also, 11217, it isn't reasonable to treat your downpayment as free. It costs money too.

Posted by: FinanceGuy at August 20, 2008 4:38 PM in response to Co-op of the Day: 123 Henry Street

Are there 90% LTV mortgages available at 6.5%? If you've got one, I'd say grab it fast. With Freddie Mac paying 4.71% for five year money, rates like that aren't going to last.

What happens to prices if rates go up? Will the hit be taken by buyers paying more or sellers getting less?

Posted by: FinanceGuy at August 20, 2008 4:37 PM in response to Co-op of the Day: 123 Henry Street

Mortgage interest on borrowed part plus opportunity cost on downpayment @ 8% = 2993 , plus 772 maintenance = 3765.

I didn't check current mortgage rates, so if 8% is too high or too low, just plug in the number you think is better. I doubt that any realistic mortgage number will get you below current market rents, but maybe rents are higher than I think.

I ignored the equity part of the mortgage, since you are paying that to yourself.

An owner should expect to make more on the downpayment than the bank expects on the mortgage, since the owner is bearing more risk. For convenience, I just used the same interest rate for both, although that understates costs to the owner somewhat.

I ignored the costs of repairs that a coop leaseholder but not a renter would have to pay and, conversely, I didn't monetize the privilege of renovating that the cooperator but not the renter has.

If I were about to buy in this market, I'd also want to be paid for the risk that we are at the tail end of an historic bubble and prices are likely to drop dramatically in the near and not so near term. And the risk that, as Wall Street implodes, Brooklyn Heights rents are more likely to drop than increase in the next several years. Both these mean that the true opportunity cost of the downpayment is quite a bit more than 8%; my own guess is that the likelihood of being able to recover a 10% downpayment in the next several years approaches zero. For prices to return to long-term trend, even adjusting for the increased attractiveness of NYC relative to, e.g., SF, they need to drop (in real terms) by a third, and probably that will happen by a prolonged period of flat or slightly down nominal prices. Unless the city or its economy goes downhill as a result of the finance industry reorganization, in which case prices could head for 1990 instead of 2002.

So, I wouldn't buy now unless the ownership cost was LESS, not more, than the rental cost. That, of course, was usually the case in NYC from at least the 1940s until the last few years.

Posted by: FinanceGuy at August 20, 2008 4:16 PM in response to Co-op of the Day: 123 Henry Street

Looks like a perfectly reasonable one bedroom apartment that costs (before the tax subsidy) the equivalent of about $3800 / month. For someone in a high tax bracket, the tax subsidy might cut that by $1000 or so.

Since either price is considerably more than nice one bedroom apartments rent for in the neighborhood, the prospective buyer is paying for the privilege of assuming the risk of price drops in the coming recession, or, alternatively, the progress of the housing bubble to new and even more implausible heights.

How much should someone be willing to pay for taking on that risk?

Does it matter that it would be quite easy for developers to create comparable apartments by new construction or conversion of rentals, so, long term, one would expect prices to approach construction costs and rental values?

Posted by: FinanceGuy at August 20, 2008 3:22 PM in response to Co-op of the Day: 123 Henry Street

Polemicist seems to be advocating a return to the bad old days of urban removal. I prefer a more capitalist approach to development. If developers can't convince people to sell their rights, then probably the rights are worth more than the development. Straight market.

2. Arbitrage: Arbitrage is just a fancy word for buying and selling in different markets. All it means here is that developers buy rental properties, or warehouses, and convert them to owner occupied, when the price of owner occupied is higher than the value of rentals. This increases supply which, in the long run, will decrease prices. Not by magic or with any guaranteed time frame. But that's how capitalism works.

I don't see any evidence that brownstones are priced any more irrationally than other real estate in the neighborhood. If people were paying for the art of brownstones, old ones would sell for more than new ones, and brownstones would sell for more than less artistic apartments on a per sq ft basis. The opposite is true. Housing is a commodity, not an art.

People are willing to pay for neighborhoods, which are not commodities. But when the price gets high enough, the supply of neighborhoods increases. Park Slope is at least three times the size it was when I first knew it.

And, of course, there are lots of modern facades. Virtually every "brownstone", for example.

3. In normal markets, investors expect to be paid, not to pay, for investing. That's what happened when Polemicist's parents' bought, and indeed in virtually any time in NYC history before this latest run-up got going. You can count on sales prices dropping to the point where renting will be more expensive for comparable spaces.

4. If there aren't any direct rent to sale comparables, just adjust for sq footage and condition. It isn't exact, but it's close enough to tell you whether someone could make money by shifting usage (arbitrage). In any event, markets are rarely precise -- if they didn't get out of whack, there wouldn't be any way for finance guys, or developers, to make money.

Posted by: FinanceGuy at August 9, 2008 6:39 PM in response to News Flash: Everyone Wants to Live in the City

wburghipstersaredirty's analysis is quite good, except for one thing: there is no city in the world that has long term appreciation as high as 2% over inflation. Shiller has charts if you want empirical evidence. At that rate, the city would rapidly become unaffordable to its residents, far more expensive than its neighbors and lose its attractiveness.

Long run, housing prices track construction costs, which track inflation, not more.

In NYC, medium run, the city has become more attractive than it used to be (although the same is true of most of its competitor cities). Brooklyn has also become more attractive relative to Manhattan than it used to be. Both of these could sustain some secular price increase.

The improvement in NYC quality of life should be reflected in rents -- and indeed, Brooklyn rents are closer to Manhattan, and higher than Westchester, than they used to be.

Rents are far less susceptible to bubbles and funny finance than sales prices. No one pays higher rent today because they think they'll be able to flip the apartment tomorrow. And rents can't go up much faster than incomes for long or you run out of renters.

NYC housing is readily converted from one to the other. So long as sales prices are higher than rental values, rentals will convert to single family owner occupied. So long as sales prices are above the cost of construction, more stuff will be built.

So comparing rents to sale prices is a good way to filter out the bubble and see only the real improvement in the neighborhoods. If you are trying to figure out what is most likely to happen to prices in the future, your best bet is to assume that sales prices will drop until they meet rental values and construction costs.

Wasder says he is paying less for his house than he did in rent. If the two places are more or less equivalent, and if he is including the opportunity cost on his downpayment as a cost, then that's a pretty good sign that he paid a fair price.

Posted by: FinanceGuy at August 9, 2008 5:57 PM in response to Auction Time for 306 St. James Place

Polemicist:

1. Fear of future profit-restrictions obviously could reduce investment in new building.

But the problem then is fear, not rent stabilization. Abolishing rent stabilization won't help that, at least as long as tenants continue to have the right to vote and they continue to view monopoly pricing power as immoral and inefficient.

Actually, the best way to end *fear* of increased rent stabilization is to enact the strictest imaginable scheme right now. Then investors will just work with it instead of frightening themselves with populist fantasies.

2. The difficulty of assembling development sites is an inevitable consequence of any property-based regime. The only way to "solve" this problem is to give developers the right to expropriate others. That cure is worse than the disease. Under capitalist regimes, developers can only develop if they can persuade existing rights-holders to accept payment for their rights. If they can't do that, then presumptively their development activities are not efficient. Stealing the rights of tenants would make development easier, but not more efficient, fairer or more socially useful.

3. It would take a significant price drop for Park Slope brownstones to sell for less than replacement cost. Renovated brownstones with details do not sell for a noticeable premium over similar sized brownstones with modern renovations. So, in the end, it seems that the marginal buyer is buying neighborhood and house and renovation, not Victoriana. Thus, modern construction costs are the point, and it is not hard to build a comparable space to this (less than pristine) brownstone for less than $700 per sq ft, as evidenced by the fact that developers are still managing to buy overpriced land/buildings and create new properties at current market prices all over our area.

4. In most suburbs, but not in brownstone Brooklyn, there is not a fully comparable rental market for upscale single family homes. Moreover, zoning often makes conversion from owner occupied to rentals or vice versa difficult. Hence the Appraiser's rule is not irrational.

But in Bklyn, we are blessed with a deep and liquid market in many housing types and the zoning regime places few restrictions on arbitrage from one to the next. If rental and owner prices get out of whack, as they are now, rentals will continue to be converted to owner-occupied until equilibrium is restored. Pre-bubble, honest appraisers in brownstone Brooklyn always weighted rental value heavily, and post-bubble they will go back to doing so.

Posted by: FinanceGuy at August 8, 2008 5:34 PM in response to News Flash: Everyone Wants to Live in the City