Historical Rent to Price Ratio: 5%

Hmm... according to this study, then, from 1960-1995 the average GRM was between 218 and 240. I guess my estimate of 200 was just slightly low. But I always did say that my calculations did not take into account the long-term appreciation of real estate or any intangible advantages of owning vs. renting.
 
This backs up the idea that a GRM of 160 is simply too low. I notice, though, an interesting anti-panic evasion. The authors estimate prices could drop 3% a year for 5 years to return to "normal". They omit that they are forecasting a 4% annual increase in rent, indicating housing is currently about 35% overvalued in real terms. Yow.
 
The GRM of 160 is not too low. Do you believe any of the cost inputs in <strong><a title="Permanent Link to Rent Versus Own" rel="bookmark" href="http://www.irvinehousingblog.com/2008/01/14/rent-versus-own/">Rent Versus Own</a></strong> are inaccurate? The "rent" number they reference in the report is the made-up government number that is part of the CPI. That number is too low compared to the real world. They were not performing either a property-specific analysis nor an aggregate of real rental figures.
 
The devil is in the details. After reading the paper in full I'm not convinced you can directly compare their method of estimating owner-occupied rent to a GRM analysis of an individual property. An average of 230 or so doesn't pass the "smell test" in terms of other numbers I've seen the last few years. But again, even if those numbers hold, an average of 230 or so doesn't mean it can't go far below that during the dips. Especially the So-Cal market which seems to be have much bigger deviations from the mean than the nation as a whole.
 
Funny, no one noticed all the variables, different data points, and how that was on a national basis. I'm sure it will drive me nuts, and I will plug in the numbers for Irvine. Just looking at the census numbers, in 2006 the number was 2.3% and in 2000 it was 4%. So... to get back to normal, and lets say rent goes up by 5.8% a year, and 5 years later... the median price would have to drop from the $739k to $550k to return to that 4% range. I'm sure if I could dig up the data from the late 90s, then the 160 multiple would be close. But... that price drop is a nice 26% drop. That would wipe out a gain of 35%. Ouch! So there you go, that is basically what that paper is saying, oh... but I will need to find the data from the previous years too. Could be a whole lot worse then.
 
IR, the cost analysis doesn't the effects of inflation on rents and loan balances. That is very important, and adds a substantial expected gain to owning. Even fairly conservative accounting (considering only the effect on the loan balance) easily pushes the GRM well above 200.



That said, the methodological concerns are quite valid. My personal experience is that house prices do often reach cash-flow balance and according to the article they've never been even particularly close. Perhaps the national averaging "averages out" the cycle, so you're always seeing something similar to the "asset value balance". If so we would expect to see a fall to worse than the long-term average as the now largely synchronized regional markets all fall to cash-flow balance together.
 
The inflation hedge is nice, but it doesn't have a great economic value. It locks in your payment, but if you pay a premium for it, you erase its value very quickly. At a 3% rate of inflation, the premium is 10% assuming you hold the property for 30 years. The shorter your holding time, the less the premium. (I tried to post the spreadsheet, but the forum wouldn't let me.) If you compute the net present value of the difference in payments between a leveled payment and one that increases at 3% per year, you can pay up to 10% more for a leveled payment if you look at all 30 years. If you reduce the holding time to 10 years, the premium drops to 7.5%. At 5 years it drops to 4%. I did not factor in the impact of a 6% commission to exit the property. This has a strong impact on short holding periods.





I get the feeling you guys trying to rationalize a GRM of 200 or more are going to become knife catchers. The breakeven GRM for an owner-occupant is 160. <strong><a href="http://www.irvinehousingblog.com/2008/01/14/rent-versus-own/" title="Permanent Link to Rent Versus Own" linkindex="49" set="yes">Rent Versus Own</a></strong>
 
IR, we had this discussion several months ago here: http://forums.irvinehousingblog.com/discussion/877





In it, I posted my calculations on GRM and how I came up with 200. Since that discussion, I see you made an improvement to your original GRM calculation (by adding in the benefit of principal repayment), although several other small changes canceled that out and you ended up with the same GRM of around 160.





I would say the errors in your calculation are primarily two-fold: 1) Missing the tax deduction for CA income tax at 9.3% and 2) Overestimating the reserve needed for repairs. Actually, now that I do the math, I'm not sure you have the tax savings right in that calculation even leaving out the state tax issue. $2166.67 + $416.67 = $2583.34 x 25% = $645.84, not $567.71.





The second issue, how much is a reasonable reserve for maintenance and repairs, is trickier. Several people in your thread wrote saying they thought $625/month was too high as well. In the first five years I've lived in my home (although, I will admit, the home was new when I moved in), I've spent $350 on repairs and maintenance (outside of something minor that was covered under home warranty). That's $5.83 a month. I know a neighbor who had a bit more problems than me and has spent approximately $2000, or $33.33/month. My parents, who moved into a home that was 40 years old at the time, and have lived there for 25 years, have spent approximately $70,000 in repairs/maintenance over the years, and they've had to pay for an entire roof replacement, multiple roof repairs, pool/pump repairs, garage work, plumbing, electrical, etc. That's $233.33/month. Oh, and their home is worth over $1M, not $0.5M.





So, I think if you use $250/month, maybe that would be more reasonable (still high in my opinion). If you put that into your equation, along with correcting the tax issue, you get:





$3503.27 - $886.09 - $361.31 + $312.50 = $2568.37





$500000/$2568.37 = 195





Anyway, the main reason I think the numbers the researchers came up with (218-240) are reasonable is that none of this takes into account several factors: 1) Over the long term, real estate appreciates. Yes, yes, I know it won't for a few years and it'll take a few more after that to make up the losses, but I didn't say you needed to buy now, and I mean over decades. 2) Owning is an inflation hedge. 3) The above calculations are on the *worst* month possible, namely, the first month of repayment. Over the months and years, interest decreases and principal repayments increase, so the GRM can only go *up* from 200.





But, I guess we'll all see over the next two years, eh?
 
LOL, the one factor that you all seem to forget is the over-shoot of the correction. Seriously... how many years did it take during the last peak to bust? Come on... bring it, and I gave an example in Maybury Ranch in Orange, hell... the OCR did it for me. Inflation hedge my ass.





So here is my challenge...





If you buy, tell us roughly what you paid, roughly the size of the home, and in the neighborhood you buy in. I dare you, I challenge you... if you are so damn serious, then do it. I mean, you will take some backlash, but if you have the guts to buy, then you should have the guts to post about it. What? Are you afraid that you will be proven a knife catcher? Suck it up! I have, and I just posted a comp killing foreclosure in my neighborhood, and I will post about comp killers in your neighborhood, so what is the difference? Am I going to be proven wrong? Or am I to expect the typical response... chirp, chirp?
 
Irvine Allergy Dr.,





There is probably no way to settle the argument on maintenance and reserve costs. If the property is new, the quality of construction is high, and if you never renovate anything, you may have lower costs than what I have shown. As for the tax benefits, you are too high. Theoretically, what you say is true, but once you factor in the deductions you lose and the various caps and phase outs you end up getting about 25%. Tax time is coming up, run some scenarios in Turbo Tax and see what you get. Make sure to compare renting to owning, The loss of the standard deduction makes a difference. Also, over the years as your balance declines, so does your deduction. This <em>reduces </em>the GRM not increases it because you are losing the tax deduction and gaining principal.
 
graphix,



I don't know why you are so angry about this whole situation. Real estate cycles are by their nature, cyclical. This cycle was, obviously, exaggerated by certain loan standards/machinations; however, you sound like someone angry that they missed out on the inflated tech stock bubble and didn't get out in time.



If you must know, and I don't know why it would be relevant to the discussion, I bought a new home back in '02 at $206/sq ft. Back then, I already thought housing prices were quite inflated. At the peak of the market, perhaps summer of '06, comps in my neighborhood were selling at $380/sq ft. Since then, prices have fallen about 20% (over 1.5 years) with two sales within the past six months within two blocks of my home to compare with.



Anyone who knows what I post about knows I am looking to buy in Irvine mainly to relocate my wife closer to her job in Irvine. I'm willing to pay $100k just to reduce her commute from 45 minutes to 15. On top of that, I'm willing to pay for the higher price of land in Irvine. In fact, the main reason we haven't purchased yet is that we have a nine-month-old baby that sucks up quite a bit of our free time so we haven't really had the ability to go look at homes yet. When it comes to purchase price, we just aren't that sensitive to swings of a $50-100k. I look at it this way: If you are selling a home at the same time you are buying, and you are in the same general location, market timing matters much less. The lower prices drop on homes, the more you save on the home you're buying, but at the same time, the less you make on the home you're selling.



So graphix, now your turn to answer a question... why is it so personal for you?
 
Irvine Allergy Dr.,





What do you think the GRM was when you paid $206/SF? Do you happen to remember what comparable rents were at the time?
 
<p>Preface: I have a lot of respect for IR, IADr, and graphrix, thier opinions, and their postings. I feel similarly about liz and IPO and XScLM. All users have a unique perspective and have a logical and rational approach to the subject.</p>

<p>HOWEVER:</p>

<p>Recently I sense a lot of bitterness from IR and from Graph lately and I'm not exactly sure why. So, since the gauntlet has been thrown down, I'll just say it - yes, I plan on being a knife catcher. </p>

<p>IF I can find a property I like and IF I can make financing arrangments I can afford on a 30 year fixed. I will actively start looking for a knife to catch in Q1 of 2009. My motovation is to save my wife 30 minutes of commute a day by moving about 20 blocks to the other side of the 55/22 interchange. And, I need a spot to build a better spot for my race car and a place with RV parking for my trailer. </p>

<p>I am willing to catch a knife (or, as I like to say 'take the worst of it') so I can achieve those two goals. Incidentally, if CalTrans hadn't put the traffic control lights on the 22 I would likely feel different. I'm tired of Mrs. No_ being bitter in the morning because the 22 onramp backs Tustin up all the way to Chapman and preventing her from getting through the intersection.</p>
 
I apologize if I have sounded bitter. I don't know which posts of mine have come across that way. I don't feel bitter.


<em>


"I'll just say it - yes, I plan on being a knife catcher. "</em>





All I ask is honestly like the statement above. People tend to cloak their emotional decisions in financial rationalizations which do not reflect reality. It pains me when I see people do that. If you know what you are doing, and you have prepared yourself to accept the consequences of what you are doing, then the decision is right for you. I read a story in the OC Register recently about a guy who just bought a house because "prices might drop 1% or 2% more, but that is it." I shudder to think about how this guy is going to feel when prices drop another 10% to 20% in his neighborhood this year.
 
IR,





I took another quick look at the tax calculation, and perhaps you are right, it is closer to 25%. The difference is not caps on deductions, which do not apply at the income levels we're talking about ($150k/yr to purchase a $500k home), but rather the loss of the standard deduction, which cancels out the state income tax deduction from federal forms.





As to the GRM dropping over payments, I don't see the logic behind your argument. Its like arguing for keeping your loan balances high so you'll benefit from the tax deduction. You only get back 25% of those owed dollars. As the payments proceed, you are increasing principal payments (which are your savings) and decreasing interest payments (which is going to the bank, like rent). Therefore, if you look at the GRM formula, it can only increase, not decrease.





Anyway, I know I can't really convince you that 200 or 190 or whatever is any more legitimate than 160 as a GRM. All of these numbers are meaningless, anyway, to the general public, who are the ones who really will be setting what market prices are like in the next few years.
 
<em>"As the payments proceed, you are increasing principal payments (which are your savings) and decreasing interest payments (which is going to the bank, like rent). Therefore, if you look at the GRM formula, it can only increase, not decrease."</em>





You are right. I was thinking backwards. Things which reduce your cost of ownership raise the GRM.
 
" As to the rent question, if my memory serves me right, GRM for homes similar to mine at that time was in the area of 215-235."





If that was true in 2002 at a price of $206/SF, what do you think the GRM peaked at? 400?
 
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