Why I Bought A House

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Some context is needed. Yes, I just bought a house. But it is the fifth house that I have owned in my lifetime. I bought my first house shortly after I turned 25. I have no fear of residential real estate.

So it is kind of an interesting experience when I buy a house, because, by anybody’s definition, I am a financially sophisticated guy. In fact, you could probably put me in the top .01% of financial sophistication. I am a macro expert, I have an informed opinion on the future direction of interest rates and home prices. But interestingly, the most money I ever made on a house was that first one when I was 25, when I didn’t know my ass from a hole in the ground.

Most people who buy a house are financially unsophisticated. They don’t know jack about interest rates. Likely they have never seen a mortgage amortization table, or have any idea how principal amortizes over time. They have never seen statistics like the Case-Shiller index, or building permits or housing starts or new home sales. They don’t care. They like a house, they buy the house. Oftentimes, people make money in spite of themselves.

So just because I know all this finance stuff, don’t mean that I am much better off. But hear this. 3.75% on a 30-year fixed rate mortgage is a generational low and is not going much lower. If someone is offering you the chance to borrow money for 30 years at 3.75%, you should probably take it. Just saying. I actually had no debt on my last house, and I gotta tell you, the best thing in the world is not having a mortgage payment. I had the ability to pay cash for this one, too, but…at 3.75% I am going to borrow the money.

30 years is a long frickin’ time. Imagine you take out a mortgage in 1965 for 6%. Inflation is 2%. In the 70s, inflation goes much higher (including wage inflation). By the time you get to your last payment, in 1990, it is almost an afterthought, it is so small. Of course, if you take out a 30-year fixed in Japan in 1990, you are really not happy, because of deflation, but that seems unlikely here.

I may or may not have mentioned that I teach a graduate-level finance class. We do a mortgage amortization exercise in class, one of those personal finance things that people need to know. We plug in the interest rate, the amount borrowed, the number of payments, then we figure out the payment and we look at the composition of principal and interest as you monkey with the inputs. Move the interest rate from 4% to 6% and look how much bigger the payment is, how much more you are paying in interest, how much longer it takes you to build up equity. I encourage you to do the same exercise. Low interest rates are literally the best thing in the world.

The other thing about low interest rates is you can afford a lot more house for your money. If the difference between a $300,000 house and a $310,000 house is only $20 a month in the payment, you are more likely to get into a bidding war. If you are bullish on home prices (I am neutral) it is predicated on interest rates staying low.

Well, are interest rates going to stay low? That is the subject of a much longer piece, and I don’t seem to be better than anyone else at forecasting it. I think it is unlikely they go much lower. If you work in finance, and you are thinking about buying property, I can’t imagine a time when lenders would be more accommodative.

Of course, many readers of this essay live in New York City, where the calculus is very different, where real estate is obviously overvalued. But there is no reason to think that gentrification won’t continue. As it happened to Brooklyn, it will happen to Queens, and the unthinkable will someday happen—the South Bronx will become gentrified. It is actually just beginning. That is going to be the new playground for real estate speculators.

As for the Fed, well, my official call is that the Fed won’t hike until 2017. They’ll dick the dog until September at least, and then 2016 is an election year, so…the economy will run very hot by the time they get around to doing it.

Happy real estate hunting.

 

But don't asset prices move in approximate sync with interest rates? Sure, you can get a 30-year-mortgage for under 4%, but in my neck of the woods, anything worth purchasing requires two individuals making nearly $200,000/year combined. It's not exactly like desired real estate assets are cheap to purchase. With low interest rates, I can get more mortgage for my money, but not necessarily more house.

On the flip side, I can rent a Class A apartment unit for less than the PITI of a Class C condo and I get to keep my down payment for investing in other things.

 

This is my concern as well. I'm not in NYC, but real estate prices in my area are high relative to historical prices. There is also a lack of inventory in the most desirable areas of the city which has led to an increase in the development of apartment complexes. Unfortunately most of these apartments will be $800k minimum when completed with the median likely over $1mm.

 
Aedius:

This is my concern as well. I'm not in NYC, but real estate prices in my area are high relative to historical prices. There is also a lack of inventory in the most desirable areas of the city which has led to an increase in the development of apartment complexes. Unfortunately most of these apartments will be $800k minimum when completed with the median likely over $1mm.

Yeah, and this goes back to interest rates. Has the U.S. population just boomed in the last 5 years or do we think asset price appreciation is tied to historically low interest rates creating an imbalance of supply and demand? The OP's thinking isn't unique--in fact, it's common wisdom right now. "Interest rates are insanely low! You'd be crazy to not buy and lock in long-term rates!" Well, when the common wisdom is to buy, assets appreciate. And what does that mean to us in the practical sense? It means we get more mortgage for our money, not more house for our money.

So I'm sitting on quite a lot of idle cash. When the right investment comes along I'm going to pounce. In the interim, I'm not going to worry about my rent/buy calculator. To me that's playing small ball.

 

Not for nothing, but everything you mentioned is elementary and doesn't affect the business case for whether or not you should buy a house. Amortization tables... wtf??? "the economy will run very hot"?! where have you been the last six years?? If you think interest rates will ever normalize, then home values will crater. Homebuyers don't buy a house; they buy a payment. Higher interest rates translate into smaller mortgages for the same payment. The only real estate you should be buying is $1MM+ because the relentless bid of money laundering from BRICs is a better bet than the economy ever picking up from its enormous debt burden.

 
24cigars:

Not for nothing, but everything you mentioned is elementary and doesn't affect the business case for whether or not you should buy a house. Amortization tables... wtf??? "the economy will run very hot"?! where have you been the last six years??
If you think interest rates will ever normalize, then home values will crater. Homebuyers don't buy a house; they buy a payment. Higher interest rates translate into smaller mortgages for the same payment.
The only real estate you should be buying is $1MM+ because the relentless bid of money laundering from BRICs is a better bet than the economy ever picking up from its enormous debt burden.

I'm struggling to understand what you're saying here because you're quoting me on stuff that I never said or discussed, e.g. discussion of amortization tables and that "the economy will run very hot". Since I never discussed any of those things nor made those comments, I'm struggling a bit with how to respond.

 

You don't cover what happens in the event of interest rates returning to normal levels... Yes, you have a nice low payment, but if mortgage rates jump to 8.5% (I'm guess based off http://research.stlouisfed.org/fred2/graph/?g=NUh#) that's going to crush asset prices. My point is not to say you made the wrong decision, but rather the whole thing is a crap shoot (as you allude to).

 

Man, people have short memories. Leverage, and that's all this is, cuts both ways. Not saying buying a house is a bad decision - it actually is probably good for most ppl most of he same. BUT it's not unrealistic that you buy a house, we hit a recession, you lose your job, and you have to sell into an illiquid market or even default. And you are out your downpayment .. a big fat zero return on what was probably your life savings. And by the way, everything is correlated against you in this scenario.

My advice - keep dry powder and be the BUYER in this scenario, not the seller. Low interest rates alone are a poor reason to take on debt.

 
HedgeHog:

Man, people have short memories. Leverage, and that's all this is, cuts both ways. Not saying buying a house is a bad decision - it actually is probably good for most ppl most of he same. BUT it's not unrealistic that you buy a house, we hit a recession, you lose your job, and you have to sell into an illiquid market or even default. And you are out your downpayment .. a big fat zero return on what was probably your life savings. And by the way, everything is correlated against you in this scenario.

My advice - keep dry powder and be the BUYER in this scenario, not the seller. Low interest rates alone are a poor reason to take on debt.

I think I'm more in line with this train of thought. While rates are very low, "free money" isn't a standalone reason to take out a mortgage. However, if ASSET prices look like they will hit a trough and rates are reasonable, then maybe some detective work might be in order.

Jared Dillian:
Of course, many readers of this essay live in New York City, where the calculus is very different, where real estate is obviously overvalued. But there is no reason to think that gentrification won’t continue. As it happened to Brooklyn, it will happen to Queens, and the unthinkable will someday happen—the South Bronx will become gentrified. It is actually just beginning. That is going to be the new playground for real estate speculators.

This sort of mentality somewhat troubles me. While you might be right, no one really has any idea what's going to happen in the future.

+1 for the article, it was good read. Personally, real estate as an asset class scares the hell out of me.

 

I'm closing on my first house later this week... and I'm a homebuilding analyst so that pretty much ensures that the top of the market is in! That said, I'm buying a rental property about 500 miles from where I live, so maybe the math is a bit different. I think it's moderately insane to be buying residential RE in the SF/Silicon Valley area at the moment. It's so obviously a seller's market out here that it makes you scratch your head a bit when you see other financially sophisticated people getting involved in ridiculous bidding wars.

Rates are extremely favorable right now, but housing turnover is not. This will likely get worse when rates go up, as ppl will face "lock-in" where they are reluctant to leave behind their 4% mortgages just to move up into a slighly bigger home/better school district etc., for which they'll probably have to pay 5.5-6%. More than likely when (if) the Fed starts tightening materially, we will face another recession, and then they will be forced to slash rates once again. That's when you'll see a ton of inventory hit the market, and that's when I'd pounce. Hopefully that recession will shake out the tech bubble along with it so that I can afford something other than a shitstain condo out here...

 
Best Response

I'm sorry - but the argument about where rates were historically has zero bearing on where they will be. This is downright dangerous thinking. Look at Japan among many other arguments against this logic. Interest rates are not inherently mean reverting. This argument implies a huge misunderstanding of how the interest rate curve is priced. In fact, with global developed interest rates going negative, there is tremendous technical gravity for long-end rates thus US mortgage rates. Even if the fed hikes I doubt mortgage rates move materially. In essence, to everyone else, don't believe the hype. Low interest rates is nice icing on the cake if you have other reasons to buy property, but there is no rush, it's much more likely than certain people here imply that low rates will be around for a long long long time. There will be a new "mean," for sure.

In fact, let's do a fun little study. How much would everyone on this board pay me for an option (assuming no credit risk) that pays them $1000 if 30 year mortgage rates touch 5% some time in the next 2 years? Ie if you pay me 500 it's an even money bet. If I like the price id be happy to make the bet (put the $ in escrow etc).

 

I agree that I think we've seen a structural change. I don't think interest rates will be going up to historical levels soon because, frankly, the U.S. economy isn't strong enough to sustain it, hence the Fed isn't going to be targeting those rates.

 

I bought a house in 2013. Rate is 3.375 30 yr fixed. I now rent it out for $500 more a month than my mortgage. Thought about selling it and after expenses would make around $105k, instead I kept it and rented it out. If home prices appreciate at 2.5% and I invest the $500 a month in S&P500 index funds Id make about $25K more over three years than if I just took the 105k and put it in index funds. Key to buying homes is don't overpay like some dummies. Oh and location, location, location.

 
ryemoo:

I bought a house in 2013. Rate is 3.375 30 yr fixed. I now rent it out for $500 more a month than my mortgage. Thought about selling it and after expenses would make around $105k, instead I kept it and rented it out. If home prices appreciate at 2.5% and I invest the $500 a month in S&P500 index funds Id make about $25K more over three years than if I just took the 105k and put it in index funds. Key to buying homes is don't overpay like some dummies. Oh and location, location, location.

Do you ever have to pay for property taxes, insurance, repairs, or upkeep?
 
ryemoo:

I bought a house in 2013. Rate is 3.375 30 yr fixed. I now rent it out for $500 more a month than my mortgage. Thought about selling it and after expenses would make around $105k, instead I kept it and rented it out. If home prices appreciate at 2.5% and I invest the $500 a month in S&P500 index funds Id make about $25K more over three years than if I just took the 105k and put it in index funds. Key to buying homes is don't overpay like some dummies. Oh and location, location, location.

No, the key to buying homes is timing and luck.

As an example, my mother got re-married in 2005. After getting married she bought a house with her husband and they got absolutely annihilated--value of their home fell 50%. My brother got married in 2009. After a year living with his wife in a rental apartment they decided to buy a house. Turns out they bought at the bottom of the market and are up about $150,000 in 4 years.

 

Why are all the comments assuming the asset prices are higher automatically? Depends on your market. But you'd analyze that and look into the development plans for the community you're buying into first right? And you'd get something in a rentable area in case you lost your job.

 
Jo110:

Why are all the comments assuming the asset prices are higher automatically? Depends on your market. But you'd analyze that and look into the development plans for the community you're buying into first right? And you'd get something in a rentable area in case you lost your job.

A market flush with leverage at historic rates is one in which buyers have greater ability to pay. You see precisely the same effect in private equity. Cap rates are thin in hyper geographies and the economics of single-family home ownership have never appeared particularly compelling to me.

With that said, I believe the single most underappreciated cost of home ownership is lifestyle friction. People take out a mortgage and in so doing solder themselves to their present environment. You can't afford to accept a job with lower income, changing geographies suddenly involves a lengthy sales cycle, should your income outpace your expectations you may find yourself in a space you've outgrown, and so on.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

An interesting article with some assumptions that are a bit surprising based on the self-proclaimed financial astuteness. Maybe chew on this quote for a while: "Of course, if you take out a 30-year fixed in Japan in 1990, you are really not happy, because of deflation, but that seems unlikely here."

So for someone who is among the .01% of financial knowledge to say this is a bit surprising given the state of the current economic/market/asset cycle. Well, you know what they say about academics...

I would agree that rates are at generational lows but asset prices may be at generational highs. That throws a wrench in things, no?

Then to quote this: "30 years is a long frickin’ time. Imagine you take out a mortgage in 1965 for 6%. Inflation is 2%. In the 70s, inflation goes much higher (including wage inflation). By the time you get to your last payment, in 1990, it is almost an afterthought, it is so small."

That there, is the answer to what its like to buy a cheaper home when asset prices are lower and rates are higher. A far better decision IMO. Higher rates are OK! Why is everyone so hung up on low rates? Its asinine. Especially if you're a high income earner and need a nice tax deduction.

Anyway, some good points but the obvious unfortunately outweigh the message of the story here.

 

So one of my accountant friends purchased her house for $260k at 6.5 percent. One of the kids in my Msf was approved for $425k at 3.25 percent. When we were doing the analysis we looked at amortization tables and guess what, there's a point (albeit on a long horizon) where the outstanding principal balance on a loan of almost twice as much is lower than the balance on 260k. So what's the problem with looking at amortization tables and factoring that into the decision to buy?

 

It's definitely not fool proof. Back in 2007 I was offered a arm mortgage for a 500k townhouse on my low low recent grad salary at the time. Mind you interest rates were at then historic lows at that time too. It's fools who would have taken it....doesnt mean real estate is dangerous. Means liquidity was dangerous. there's a difference. and a reason why liquidity is backed with an asset...the house. That's what foreclosure is, a bank taking a house because ultimately it's still worth money.

 

A mortgage is forced savings. That's why "rich" people mostly own real estate. The savings part makes them "rich," not the real estate/investment part. Has nothing to do with how good of an investment it is. My issue is that, all else being equal, a house/mortgage is not the ideal investment because it's highly illiquid and it's usually a huge % of one's net worth. You're selling a barrier option on most of your net worth and if the barrier is hit (forced sale/default on mortgage), you're screwed. Lesson 1 is you never want to be a forced seller into an illiquid market (job loss usually correlates highly to other job losses, when no one has money to buy houses, banks are under stress, and the market freezes). Other means of saving / investing allows you to be more diversified and opportunistic. But that assumes you will actually be responsible with money, which most people cannot/are not trained to be. So thus, housing is the best option for most people at most times, even though it is not ideal (lifestyle choices aside) outside of being a buyer in the aforementioned distressed times, and the supposedly financially savvy folks will realize this.

 

Sure, owning a home in an illiquid market like Gary, Indiana isn't the best investment. However, if you'd owned and invested in real estate basically anywhere in California, New York, Northern Virginia, Washington DC metro, Austin TX, Denver.... basically anywhere with jobs you're getting wealthier while owning property.

 
ryemoo:

Sure, owning a home in an illiquid market like Gary, Indiana isn't the best investment. However, if you'd owned and invested in real estate basically anywhere in California, New York, Northern Virginia, Washington DC metro, Austin TX, Denver.... basically anywhere with jobs you're getting wealthier while owning property.

Please stop. You're just sounding like an idiot at this point. Real estate can go down in value, anyone who doubted that realized they were incorrect in 2008. Everyone except you, apparently.
 

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