Amish Paradise — Al Yankovic
The wheels of progress keep turning here at the Irvine Housing Blog. Some of you may have noticed that we have introduced a new rent versus own decision calculator. It is still a work in progress, but it is good enough to put on the main site. We hope to add some formatting and create a stand-alone version for people to download and use.
Our goal was to create an accurate and detailed accounting for the true cost of ownership. This is a point-in-time calculator. You are not asked to make assumptions about inflation or appreciation. There are no projections for the future. People who invest in real estate (I am not talking about stupid amateur speculators) always look at the stabilized cashflow in the first year of ownership. If it doesn’t make sense in year 1, then it isn’t an investment, it is a speculative gamble. There are a variety of rent versus own calculators out there. Most are put up by realtors. They are totally biased and ignore costs and exaggerate benefits. Some are put up by bubble bloggers that are biased the other direction. We want to be accurate.
Most of the underlying assumptions are documented in the post Rent versus Own. Most of the inputs are in the left-side column, and most of the outputs are on the right (the exception is the HOA fees which are plugged in directly on the cost side). Play with these assumptions at your own risk. As I documented in the Rent versus Own post many of the costs are underestimated, and many of the benefits are overestimated. The most common mistakes are to ignore maintenance and replacement reserves and to overestimate the tax savings. The true tax benefit is not the highest marginal tax rate you pay.
The primary function of the calculator is to determine the true cost of ownership to compare to a base rent. However, we have added a reverse calculation that allows renters to put in the rent they are currently paying and show them how much house they can afford. Since this is not a spreadsheet calculation and we could not iterate to run the calculations backward, we cheated: we use a percentage of rent that goes to the cost of ownership beyond the payment and subtract this from the rent to compute the purchase price, downpayment and loan amount. You will see the two methods produce very close results both forward and backward.
Any comments or suggestions for improvement will be appreciated.
In other news, I wanted to remind everyone that we are having an Irvine Housing Blog party and book signing at 6:30 on Wednesday, November 12, 2008, at JT Schmids at the District. All who wish to be a part of the IHB community and meet others
in the community are encouraged to attend. We may have staff writers and photographers from OC Weekly in attendance to write a story on the IHB community. You can avoid the pictures and remain anonymous if you wish. Participation is voluntary.
Look for an interview with me in the Irvine World News on Wednesday and the OC Register on Thursday.
I was having a conversation about current events and the massive deleveraging we are witnessing globally and I realized something rather remarkable: most residents of California have seen their new worth decline 40% or more over the last 2 years. Think about that for a moment. The California median home price is down 40% according to the California Association of Realtors. Since houses are almost always hugely leveraged, many homeowners have lost all the net worth they once had as equity in their houses. The stock market is more than 40% down in the last year. Anyone invested in the market either directly or through their retirement plans is down 40%. Stocks, bonds, real estate, commodities, and currencies: nearly every asset class is down, and down big. The only group that has not seen a huge decline in their net worth has been renters who are mostly in cash.
What is going to become of this huge “reverse wealth effect”? There have been many studies on how much people spend when their stocks or houses appreciate. I don’t think anyone have every studied what people do when every asset they own declines significantly in value. I don’t know if it has ever happened before. You have to imagine this will create a giant sucking sound in our economy. The only people who aren’t impacted by this and who don’t care are the Amish. Maybe there is something to be said for the simple life…
We have talked about cash being king. Right now, it really is.
{book}
As I walk through the valley where I harvest my grain
I take a look at my wife and realize she’s very plain
But that’s just perfect for an Amish like me
You know, I shun fancy things like electricity
At 4:30 in the morning I’m milkin’ cows
Jebediah feeds the chickens and Jacob plows… fool
And I’ve been milkin’ and plowin’ so long that
Even Ezekiel thinks that my mind is gone
I’m a man of the land, I’m into discipline
Got a Bible in my hand and a beard on my chin
But if I finish all of my chores and you finish thine
Then tonight we’re gonna party like it’s 1699
We been spending most our lives
Living in an Amish paradise
I’ve churned butter once or twice
Living in an Amish paradise
It’s hard work and sacrifice
Living in an Amish paradise
We sell quilts at discount price
Living in an Amish paradise
Amish Paradise — Al Yankovic
I like that you can play with the interest deduction. Works well with your neighbo(u)rs, if you know what I mean.
Hey, I fooled around with the calculator a tiny bit, I love it! Need those positive affirmations to keep me on the sidelines renting for a while.
Per your calculator, assuming all else remains the same (I know, not a good assumption), prices need to come down another 10% before I’m even up. For me there is a premium for owning because it provides more stability and flexibility, which is necessary when you have kids. I’m sitting tight….better make sure I still have a job next year, too, in addition to waiting for that price decrease.
Thing that was and continues to be funny about this was the large number of people and the media that kept saying 50% was impossible, it just couldn’t happen. Well, we’ve hit 40% and 50% isn’t far off. In some areas it’s worse and in some, few, it’s better, for now.
Have prices come down 40% in Irvine?
Nope, the decline in Irvine is around 20%. We still have quite a fall in front of us.
There is a subtlety with the maintenance cost. When I have previously seen maintenance cost calculations, they used the same % of price regardless of when you purchased the house. That can’t be right. The house doesn’t “know” that it was sold during 2000 for $200,000 and 2006 for $600,000, and therefore it should have three times as much maintenace expense after being resold. Nor will the house know that it should have fewer problems after being sold yet again for $350,000 as a bank REO in 2008. All of those changes could happen without any remodeling. The price differences were primarily caused by the value of the land.
For maintenance, I have a feeling that it could be priced per square foot and in consideration of the age of the house.
The other factor with maintenance cost is how handy you are. If you can fix the small stuff yourself and can stay on top of any contractors you hire, the costs can be much lower then if you have to hire contractors for most repairs.
I know it is very difficult to enter this factor into a calculator, but it is a big factor and one that allows many landlords that own a handful of properties to turn a nice profit on what may be a break even scenario for the less handy.
Oh, and the cost of insurance has a similar problem to maintenance. It’s not the cost of the house+land that determines the insurance, it’s the cost of reconstruction. Having a cost estimator that uses square feet, and perhaps whether it is basic, typical, or deluxe would help. If you wanted, you could also put in region to help estimate reconstruction costs.
These types of estimates could work with the RS Means Cost Per Square Foot estimates. That way you would have a third party estimate that is regularly updated for various parts of the US.
Otherwise, insurance prices will be overestimated for people buying overpriced homes, or homes in neighborhoods with more expensive land.
I will try to figure out a way to do this without making it too complicated.
The easy way to do this now is to simply adjust the % for maintenance and replacement reserves to compensate. An older home selling at near its replacement cost would have a high percentage while a new home selling at a large land premium would have a smaller replacement cost.
renters can and should be renters insurance also. i haven’t boughten this in ages but my guess is that this adds $30-40/month to your rental cost.
You shouldn’t put in one without the other.
My renters insurance is $80 per YEAR. Two bedroom apartment with itemized expensive items (but none more than $400 replacement cost).
Just a comparison point. Insurance for your stuff, is not that expensive.
According to the California Dept. of Insurance premium survey, for renters insurance coverage of $75K with a $500 deductible for Irvine, the lowest annual premium is $227 by Grange (AAA is $261, State Farm is $262).
http://interactive.web.insurance.ca.gov/survey/survey?type=homeownerSurvey&event=homeownerSearch
Who has $75k worth of stuff? Man no wonder everyone HELOC’d themselves over the edge to keep up with those darn renters. 😉
But yes, apparently everything in California is more expensive, $25k of coverage with a $250 deductible is about $190/year. More than twice what I’ve ever paid in urban areas of NJ, MA, MD or VA. Go figure. Must be the fires and earthquakes (if those are even covered).
Yeah, it’s certainly easier to build up that much stuff when you’re renting (and have a decent income). I don’t think it’s all that uncommon.
And no, earthquakes are not covered — you need to buy a separate rider for that. Before the insurance companies lost so much money in the Northridge quake, it was often included. For a while after that, you couldn’t buy earthquake insurance at all, if you didn’t already have it. Now you can again, but it’s always at an additional cost for the rider policy (and it’s pretty expensive given the coverage level).
I think wildfires are covered in the main policies, but would have to check.
Yes, good point (despite the “boughten” ;^>).
As another data point, my IAC-mandated renter’s insurance from Deans & Homer (which is their in-house provider, and which I found to be somewhat cheaper than the alternatives at the time I started with it a few years ago) is $264 a year.
IR,
Your timing on this is perfect, I just got an email last night from a cousin in Sacramento asking if he should continue to rent or buy. The one thing I think you’re missing is the Mortgage Insurance Premium. Is that already built into the payment, I didn’t see a separate line for it.
You are correct. We will add a line for PMI.
Did you factor in the cost that the downpayment could have been invested over the holding period to earn more money, but instead, was sunk in a house?
The final line, “Lost Income to Down Payment” is where you put in the return you believe you would obtain on the investment of the downpayment in another asset class.
What is that estimated ownership costs at the bottom under montly rent?
How did you come to the defaul of 18%? What is the range of what could be?
I like being able to both work and put in the rent first, then I know what would be a comparable house.
The 18% is the net cost of ownership over and above the payment. Most people think only in terms of the payment without considering all the other costs.
maybe it would be worthwhile to put an information area so when you float the mouse over it..it describes the field. just an idea.
I agree. Having an info section/column (or pop up window) explaining each line item would be helpful for the general public.
IHB, thanks for this tool.
IR,
Very good tool. While my calc to own showed me that the monthly bill on my house would be $2300, which would in fact be $100 more than what my rent would be, I will be moving in a bigger house (say, 400 sf more). Ideally should I calcuate it against the rent for a comparable property, or just check my current rent against the mortagage to establish rental parity?
It’s agenuine question- not trying ot chew yuour brains off:-)
My would-be buy is justified with rental parity when it’s comes to a rental it’s own size, and not so with my current rent.
You should be checking the cost of ownership to a comparable property.
Just plugged in the right numbers, and looks like I am at an even out (rent is $6 expensive than owning), and ready to take the plunge. I know, we still have some more free falling to go, but later on, it will be hard for us to get a loan- I am “almost” losing my job, and with several thousands of jobless architects out there, I see no hope in near future to find a secure job. So, I will close my eyes and catch that falling knife and hope that I am not going to bleed much:-)
You and Ipop have been great help through your posts/ analysis in the past year for us.
Question: Is it OK to come clean with the name a realtard who tried to mislead us? I would love to write about my experiences about the realtard on the forum and alert others from using her..
CZ
A.G. knew the day will come, but the year will be 2010, not 2008.
Back to 2001, in order to stay as Fed chair one more term he made a deal with Bush to create this bubble, and thought he can get away will clean hand. It would have been a prefect plan, should he leave the interest rate to 3.25% not 4%, when he left the office. But he wanted to have a perfect period.
With globalization and information technology revolution, the world is much smaller than he acknowledge. AG misjudges that the meltdown will come so fast. After all, he belongs to last century.
For many reasons, Bernanke intentionally raises the rates to the level that will accelerate the crashed, but he did not image that this lead the financial crisis like a tsunami.
did you figure in the cost if you have to move because of a job?
moving costs would have to be amortized over the length of ownership so if you own a property for 30 years they are negligible.
years ago the rule of thumb was you needed to stay in your house at 7 years to justify buying. that will be the norm again.
The video is “no longer available”. Not that I was hankering for Weird Al or anything….
Wow! I must be Amish! I thought I was Jewish and Mooish.
Understanding Bushonomics – How we got into this mess in the first place
http://www.americanprogress.org/issues/2008/08/pdf/bushonomics.pdf
Thank you, IR.
One small suggestion for improvement…
Should the line item for “Special Taxes and Levies” be a flat value and not a percentage-based amount?
thx again.
You’re right…I’m renting for half price and am 70% in cash….er, maybe 75% now that my stocks are down! 🙂 I feel great. Cash is king…and I am on the throne!
The calculator is great. I think you should include private mortgage insurance for those people who have less than 20% down. Otherwise, the calculator underestimates the cost of owning.
One other reminder for the calculator. A large portion of homeowners don’t itemize. They don’t get an additional interest or property tax deduction.
I am trying to come up with a way to make that a simple calculation. Part of it is easy, “Would you itemize (rather than taking the standard deduction) even if you were not a homeowner?” If the answer is yes, the marginal tax rate does the correct calculation.
However, if someone has almost no itemized deductions (e.g., living in a state with no income tax), they might not be able use much of the interest and property tax deduction. In fact, if they bought a $150,000 condo or house, they might not get any tax benefit.
Even in the highest income brackets, 22% of homeowners still don’t itemize. Many of those might not have a mortgage. However, for homeowners near median income, much less than half itemize. http://www.owlnet.rice.edu/~econ461/papers/w9284.pdf
IR, I assume “new worth” was meant to be “net worth”? (The former could make sense too, so had to ask.)
Turns out, I am a “mooselim”. Oh well. Not a bad thing, I guess. I could never understand doing anything with a house (your primary, anyway) but buying what you can afford, and then paying for it as quickly as possible. And keep it payed for, excepting an emergency. You would be surprised how easy that is if you put your mind to it, and your luck is good. And when you do own it, you now have something to lose, which tends to make you conservative in financial decisions.
The absurdity of the entire real estate fiasco is that almost everyone ruined by it was in a position, had they not succumbed to temptation, to house themselves adequately and securely.
In my case, it was, to be honest, sheer laziness. To much effort and hassle to get a loan, and you have to sign your name a zillion times, which I hate doing.
For the tax savings, if you itemize you lose the standard deduction. For most people, all their itemized deductions other than their mortgage insurance will be much less than the standard deduction, so most of the standard deduction value should be counted against your mortgage interest tax deduction.
I hope that made sense.
While we are currently currently seeing a significant dip in the market, it’s important to remember that property prices do tend to increase over time. This has the effect of significantly reducing the cost of ownership.
The 20%/year appreciation of recent years was clearly unsustainable. However the more recent plunge in values is also unsustainable – this too shall pass. It is reasonable to anticipate a moderate, but compounding, appreciation of the property over time.
Let’s say that property tends to appreciate at a conservative rate of 3% per year. For the $500,000 default case, this translates into a $1,250/month equity gain. Subtracting this equity gain from the “Total Cost of Ownership” value significantly alters the balance in favor of owning.
Real estate is a long term investment. Buyers should anticipate a 7 to 10 year horizon. The days of flipping are gone, but with a realistic time frame it’s very realistic to anticipate moderate appreciation.
“but it is good enough to put on the main site. We hope to add some formatting and create a stand-alone version for people to download and use.”
I can not find a download link anywhere on the website–is there a place we can download the calculator?