The Buy vs Rent Calculation in VHCOL area

[jellowars]

My understanding here with the buy vs rent calculation is that if the non-equity costs of buying (the ITI in PITI + HOA fees + maintenance) exceed what it would cost to rent something equivalent, then it favors renting. Does this apply in VHCOL areas as well?

Our area is like this, where renting a 2-3BR place (in a good/safe part of the city) is $5k-6k per month, and then buying a similar place is upwards of $1.5M (seems like it goes up even more each month) and so the raw math does work in favor of renting. But are there other benefits to buying that go beyond the simple numbers, which we should consider? It does hurt to put that much $$ into rent each month, but we can definitely afford buying or renting in this area and still hit our savings goals ($600-800k household income which is projected to go higher in the next few years, minimal debt remaining, relatively frugal lifestyle).

It makes sense to buy as we start to expand our family and plan to stay at least 5 years in this area; I just want to make sure we're considering all the appropriate factors since the numbers don't seem to be working out as well. I can't really see the housing market going down (maybe it'll go up at a slower rate, but certainly not down), so I must be missing some additional benefit to buying.

[bovie]

I can't really see the housing market going down (maybe it'll go up at a slower rate, but certainly not down)

Careful there…

[Tim]

Careful there…

A bet on continued housing appreciation exceeding long term averages is risky. Say 10% transaction costs in exiting in 5 yrs needs to be added into the math.

[xraygoggles]

I can't really see the housing market going down (maybe it'll go up at a slower rate, but certainly not down), so I must be missing some additional benefit to buying.

This is the kind of stuff you normally see before corrections occur.

Btc to 1 million, Tesla to 30k by 2030, GME hasn't squozen yet, et al.

Here's an investing tip for you: no market - whether it's equity, bond, commodity, cryptocurrency, or real estate - goes up in a straight line. There is always a correction. And usually, the more it's gone up, the more it will correct, short-term.

[cards67]

I believe renting makes more sense if the invested difference between rent vs homeownership costs comes out ahead of expected future home value. Taking into consideration inflation of rent and such. In my hcol area I think it came out a wash when I did this calculation years back. Having said that, we bought because we plan on being here for life and want stability. I have a feeling 6k rent vs 1.5M home may favor homeownership, but with a 5yr horizon and your income, I don't think you can go wrong either way.

[jellowars]

This is the kind of stuff you normally see before corrections occur.

Btc to 1 million, Tesla to 30k by 2030, GME hasn't squozen yet, et al.

Here's an investing tip for you: no market - whether it's equity, bond, commodity, cryptocurrency, or real estate - goes up in a straight line. There is always a correction. And usually, the more it's gone up, the more it will correct, short-term.

So do people anticipate the housing market going down? Does that happen (aside from catastrophes like in 08-09)? I always viewed housing appreciation as a constant upward trend (although the slope of that line changes) because land is always appreciating, especially in these HCOL areas. We definitely want to buy at some point; I'm just worried that things will continue to increase and at some point we'll be completely priced out of what we want. I'm not an expert on real estate by any means so correct me if I'm wrong

[Tim]

So do people anticipate the housing market going down? Does that happen (aside from catastrophes like in 08-09)? I always viewed housing appreciation as a constant upward trend (although the slope of that line changes) because land is always appreciating, especially in these HCOL areas. We definitely want to buy at some point; I'm just worried that things will continue to increase and at some point we'll be completely priced out of what we want. I'm not an expert on real estate by any means so correct me if I'm wrong

Just because the combination of a desirable location and high paying jobs makes housing VHCOL doesn’t mean that it will continue .
Conditions on the west coast have been on the rise for quite awhile. Most recently tech.
A lot of competition from high paid individuals and limited options.
Believe it or not, Detroit and the rust belt had a day too. Ford, GM, Chrysler and all the steel companies and suppliers were in rust belt cities.
Not very expensive now. The average house price in Aspen is $14.8m.
You could see tech decentralize, move or use remote options much more. Less demand.
Not a prediction, but demand could drop, taking housing down.

[bovie]

So do people anticipate the housing market going down? Does that happen (aside from catastrophes like in 08-09)? I always viewed housing appreciation as a constant upward trend (although the slope of that line changes) because land is always appreciating, especially in these HCOL areas. We definitely want to buy at some point; I'm just worried that things will continue to increase and at some point we'll be completely priced out of what we want. I'm not an expert on real estate by any means so correct me if I'm wrong

If that were the case then why are we even having this discussion?

Why wouldn’t you just go out and by the most expensive house you could afford (or more) with maximum leverage?

[Dont_know_mind]

I think the buy vs rent calculators are stupid if you do not calculate the likely capital appreciation of the real estate.

Just like the dividend return and capital gain on stocks is related to the underlying long term trend in earnings for companies in the index, the long term return of the residential real estate in that area is correlated with 2 things:
1. The scarcity of the land: land use restrictions and release of new land
2. peoples incomes in that area.

As 1 is often related to 2. Via NIMBY, real estate is IMO a call option on the incomes of the people who choose to live in the area.

I just find it amazing that people invest in index funds and can’t apply the same reasoning to real estate.

[Tim]

Dont_know_mind
Yes. But most don’t figure the carrying costs and the cost of selling and the opportunity costs.
A real estate investor does.
Not many real estate investors go through the numbers and are content with zero income. Some ultra wealthy do park wealth in land speculation.

Home buyers tend to underestimate the costs and overestimate the appreciation. Natural in out of pocket costs in rent vs buy when the desired outcome is buy. I think the message is, don’t blindly expect appreciation will bail you out for the consumption (foregoing rental income). It’s gone.

What inflation adjusted rate of appreciation would you suggest? That would be a constructive discussion.

[Dont_know_mind]

If that were the case then why are we even having this discussion?

Why wouldn’t you just go out and by the most expensive house you could afford (or more) with maximum leverage?

I guess if you had bought a 3M house with 600k equity in 2009 in most places in the US, you’d be doing about the same as the investor who invested that 600k in US stocks.

What’s surprising is that the RE investor is not doing better considering it’s behaviourally harder and much riskier to buy an individual 3M house with 2.4M debt than an unlevered 600k in index funds, so it should have a better return. Which makes me wonder if there’s even further to run for RE. But who knows. No one knows what the actual return will be in the future.

I guess if anyone knew what the capital return rate would be in any asset class and the borrowing cost over the period, They could just have such amazing returns by levering the heck out of it.

My guess is that people are overconfident about stock returns compared to RE due to recency bias.

In 2007 and 2022, reverse RE for stocks.
Currently everyone loves US stocks.

[Dont_know_mind]

Dont_know_mind
Yes. But most don’t figure the carrying costs and the cost of selling and the opportunity costs.
A real estate investor does.
Not many real estate investors go through the numbers and are content with zero income. Some ultra wealthy do park wealth in land speculation.

Home buyers tend to underestimate the costs and overestimate the appreciation. Natural in out of pocket costs in rent vs buy when the desired outcome is buy. I think the message is, don’t blindly expect appreciation will bail you out for the consumption (foregoing rental income). It’s gone.

What inflation adjusted rate of appreciation would you suggest? That would be a constructive discussion.

This is something I’ve struggled with and it’s resulted in me being underweighted residential RE. In my area the nominal rate of capital appreciation has been 7% pa (or 4% real) over a number of decades. It was hard to imagine that it would continue, but it has and may well continue to do so.

In my mind a 30 year fixed mortgage gives you so much convexity to increasing rates. So that would be the main attraction to me for RE debt at the current time. Prices are not that attractive but the convexity to inflation is.

[Tim]

This is something I’ve struggled with and it’s resulted in me being underweighted residential RE. In my area the nominal rate of capital appreciation has been 7% pa (or 4% real) over a number of decades. It was hard to imagine that it would continue, but it has and may well continue to do so.

In my mind a 30 year fixed mortgage gives you so much convexity to increasing rates. So that would be the main attraction to me for RE debt at the current time. Prices are not that attractive but the convexity to inflation is.

Realistic, 4% for real estate and probably for equities. For a home, the consumption factor would make real estate less attractive. As an investment, about the same.
Most don’t use an actual appreciation forecast, anchored in the recent sales price appreciation, much higher than your rational not emotional 4% real number.

[xraygoggles]

So do people anticipate the housing market going down? Does that happen (aside from catastrophes like in 08-09)? I always viewed housing appreciation as a constant upward trend (although the slope of that line changes) because land is always appreciating, especially in these HCOL areas. We definitely want to buy at some point; I'm just worried that things will continue to increase and at some point we'll be completely priced out of what we want. I'm not an expert on real estate by any means so correct me if I'm wrong

Oh I have no idea what the housing market will do. I'm just saying don't expect it to continue at this pace. In fact, it's more likely to come down, especially as mortgage rates continue to rise (4% and rising). I think historically, house prices rise at the rate of inflation (3-4% historically). We are not in normal times right now, so who knows what will happen.

If you are buying a forever home, and need one immediately, then the value makes no difference, since you will not sell anyways.

[VentAlarm]

So do people anticipate the housing market going down? Does that happen (aside from catastrophes like in 08-09)? I always viewed housing appreciation as a constant upward trend (although the slope of that line changes) because land is always appreciating, especially in these HCOL areas. We definitely want to buy at some point; I'm just worried that things will continue to increase and at some point we'll be completely priced out of what we want. I'm not an expert on real estate by any means so correct me if I'm wrong

A HCOL area can change. Think about Detroit when it was a great place to live.