So what is my prediction? After all, I'm deliberately staying out of the real estate market, so why am I making this decision. The first question is how are people able to buy at all, with prices so high? With the example 2 bedroom condo requiring over $3000 a month in cash flow, and over $2200 a month in tax-neutral cashflow, how can anyone afford anything?
Of course, people aren't paying quite this much. The buyer of a house looks at the monthly cost more than the total value, and the monthly cost is greatly reduced through the use of adjustible rate mortages, especially ones with interest-only or negative amortization. And the statistics are showing that these have become increasingly popular. Yet even with those options its not a good deal to buy: at 3.5%, the tax neutral nonsavings is still no cheaper than renting.
And these mortgage carry a price: uncertainty. If interest rates on the ARM jump from 3.5% to 4.5%, thats an extra $200 in tax-neutral cost per month for my example. And long-term interest rates are unnaturally, incredibly depressed: Roubini and Setzer argue that interest rates are artificially lowered by 200 basis points, 2%, because of asian central bank currency intervention. So if George Bush gets his way and China floats its currency, say hello to a large interest rate jump.
Assuming Roubini and Setzer (and numerous others) are correct, and that the currency situation can't last forever, or something else will cause interest rates to rise, why get an ARM? If you are going to sell in 2-3 years an ARM is the way to go as the long term uncertanty isn't significant for a short-term loan. But this is the classic bubble assumption: prices keep going up (and it has to go up at least 6% to cover transaction costs when selling). Otherwise, to reduce payments for a longer time, its a huge gamble: If interest rates go up to 6%, its tied, and beynd that, its a catastrophe. Given long term interest rates so historically low, why take the risk?
Whats worse is that people are using these alternate mortgages in order to afford a house at all. If someone is squeeking by, leasing their car and with an ARM on their house, leveraged to the hilt, what happens if interest rates jump? If the economy goes south? There is now a huge number of people with no margin for error.
So what is my prediction: Well, interest rates are going to go up a little and the market will freeze: Buyers will stop buying as their monthly costs go up, but sellers won't lower their price. Taking my example, to have the same tax-neutral cost/month, a rise in interest rates from 6% to 8% requires a drop from $450,000 to $395,000 in the sale price of the condo. So a 2% rise in interest rates in my example requires a price drop of 12%, even with buyers willing to spend the same amount as they currently are.
Now a flat market for a few years would be a nice, best-possible hypothesis. But I worry that the soft scenario won't happen. Rather, what I believe will happen is that after a year or two of freeze, with interest rates going up (and the economy shrinks as the refinanced-driven spending disappears), is that the crisis will hit: some small number of people will be forced to sell, yet buyers will be unwilling to pay more per month than they currently are. With a drop of 10% or more, this might end the bubble-mentality.
The worst case scenario, with a 200 basis point (2%) or more rise in interest rates, would thus be a huge collapse in price, as the bubble assumption is proved horribly false. And the collapse may be severe: Given 8% interest rates, the selling price to have rent-equivelent tax-neutral nonsavings cost for my example (observed over 4 years) would be $250,000, a nearly 45% drop in prices!
Of course, I hope (even as a non-homeowner) a tokyo-level collapse will not happen, and would be very unlikely (I hope). Yet a 15% drop seems certain, and a 30% drop would not be out of question. If prices dropped 30%, even with higher interest rates, then I'll probably buy a house: it gives a huge hedge against inflation, the value will go up if interest rates go back down, and the price won't be so obscenely out of line when compared with renting.
(note, minor edits for clarity)
Monday, May 09, 2005
Friday, May 06, 2005
Why I'm Not Buying A House..
As I've graduated, and now have a stable job and income, I'm supposed to think about buying a house, rather than continuing to pay rent. But with Bay Area home prices at dizzying levels, I have to ask whether it makes sense to buy or keep renting. Being logical, I decided to use everyone's favorite financial "what if" tool, a spreadsheet, to construct a model of the various costs.
But before I get to the spreadsheet, what are the costs? There's the obvious mortage payment, but there are also property taxes, insurance, maintenance, and homeowners association dues. There are also tax savings, both with and without AMT to consider. Rather than just one cost for ownership, I consider 3 costs: the raw cash-flow, the tax-neutral cost, and the tax-neutral nonsavings cost. The first is obvious: how big per month are the checks. The second value is the first reduced by the tax savings from deducting interest and property tax. The final, tax-neutral nonsavings, also excludes payments on principle.[1] It is the last two which are the key values: what you pay (some of which you get back as principle when you sell the house), and what you pay and don't expect to ever get back.
You would expect that the tax-neutral nonsavings cost to be less then rent. After all, you should be able to buy a dwelling, rent it out, and make at least some profit. And, assuming you have the cash and cash flow, if tax-neutral nonsavings is less than rent, you need to buy.
Unfortunatly, with the current prices, this is not the case. Lets use the real numbers. I live in the Richmond Marina Bay area (aka the Yuppie Prison Complexes). My rent is $1325/month for a 2 bedroom apartment [2]. Recently, another, almost identical complex with the same floorplans and the same construction started being converted to condominiums, at $450,000 to $480,000 for the 2-bedroom units. The only major difference is that the other complex has some fake lakes, which only serve to attract the migrating geese and the rotting fecal matter they produce.
There are a few other assumptions needed: tax rates, loan terms, insurance HOA costs and inflation. This spreadsheet assumes a very healthy income, with a 28% marginal federal tax rate, a 9.3% state tax rate, and a 1.2% property tax rate. The loan I assume as 6% fixed, 30 years, with 10% down: a good loan for the long haul. Insurance I assume as .2%, which is actually low: earthquake insurance in the area costs .3-.4% depending on coverage level. I set the HOA fees/maintenance to $250/month. Finally, I assume that both rent and HOA fees increase by 3% annually. Toss the numbers into the handy spreadsheet and out pop some terrifying numbers.
Buying instead of renting simply costs a fortune. Beyond the $3200 a month of cash flow (hello Top Ramen dinners), the tax-neutral cost is still an outrageous $2200 a month. The real shocker is the tax-neutral nonsavings cost: $1880 a month, or over $550 more than renting. That's a real loss of $550 a month, for the privilidge of owning a glorified 2 bedroom apartment (err, "condominium home"). I can buy a nice car for $550 a month. It takes 7 years of inflation (by which time I would save $34,000) before my monthly non-savings cost would be equal to rent. It would take 18 years! until the net cost is the same.
Note that I did not consider asset appreciation in this analysis. Mostly because I feel that this is a dangerous bubble, and over the next 5-10 years, prices are going to be, emm, interesting (more details in a subsequent post). But lets say I want to sell after 7 years. Prices will have to have gone up by another 13% to even break even compared to renting, considering the 6% cost of transaction when selling a house.
It simply does not make sense to buy in this housing market. With shacks in the Richmond 'hood going for $300k, I'm going to stick with renting. For others considering buying, in other markets, use the spreadsheet yourself.
[1] An important note: I do not consider asset appreciation in the model. When there is such a feeling of speculative bubble, I don't want to include speculative gains in the calculation. But I do assume, by considering the money paid to principle as savings, that the value won't drop below the down payment.
[2] Two other factors I'm also excluding: the complexes considered are in Richmond California (a truely atrocious school district) and are built on bay fill. In the event of a major earthquake, every dwelling in the area is going to be red tagged. As a renter, that just means I need to move my stuff. If I was an owner, even with insurance, its a catastrophe.
But before I get to the spreadsheet, what are the costs? There's the obvious mortage payment, but there are also property taxes, insurance, maintenance, and homeowners association dues. There are also tax savings, both with and without AMT to consider. Rather than just one cost for ownership, I consider 3 costs: the raw cash-flow, the tax-neutral cost, and the tax-neutral nonsavings cost. The first is obvious: how big per month are the checks. The second value is the first reduced by the tax savings from deducting interest and property tax. The final, tax-neutral nonsavings, also excludes payments on principle.[1] It is the last two which are the key values: what you pay (some of which you get back as principle when you sell the house), and what you pay and don't expect to ever get back.
You would expect that the tax-neutral nonsavings cost to be less then rent. After all, you should be able to buy a dwelling, rent it out, and make at least some profit. And, assuming you have the cash and cash flow, if tax-neutral nonsavings is less than rent, you need to buy.
Unfortunatly, with the current prices, this is not the case. Lets use the real numbers. I live in the Richmond Marina Bay area (aka the Yuppie Prison Complexes). My rent is $1325/month for a 2 bedroom apartment [2]. Recently, another, almost identical complex with the same floorplans and the same construction started being converted to condominiums, at $450,000 to $480,000 for the 2-bedroom units. The only major difference is that the other complex has some fake lakes, which only serve to attract the migrating geese and the rotting fecal matter they produce.
There are a few other assumptions needed: tax rates, loan terms, insurance HOA costs and inflation. This spreadsheet assumes a very healthy income, with a 28% marginal federal tax rate, a 9.3% state tax rate, and a 1.2% property tax rate. The loan I assume as 6% fixed, 30 years, with 10% down: a good loan for the long haul. Insurance I assume as .2%, which is actually low: earthquake insurance in the area costs .3-.4% depending on coverage level. I set the HOA fees/maintenance to $250/month. Finally, I assume that both rent and HOA fees increase by 3% annually. Toss the numbers into the handy spreadsheet and out pop some terrifying numbers.
Buying instead of renting simply costs a fortune. Beyond the $3200 a month of cash flow (hello Top Ramen dinners), the tax-neutral cost is still an outrageous $2200 a month. The real shocker is the tax-neutral nonsavings cost: $1880 a month, or over $550 more than renting. That's a real loss of $550 a month, for the privilidge of owning a glorified 2 bedroom apartment (err, "condominium home"). I can buy a nice car for $550 a month. It takes 7 years of inflation (by which time I would save $34,000) before my monthly non-savings cost would be equal to rent. It would take 18 years! until the net cost is the same.
Note that I did not consider asset appreciation in this analysis. Mostly because I feel that this is a dangerous bubble, and over the next 5-10 years, prices are going to be, emm, interesting (more details in a subsequent post). But lets say I want to sell after 7 years. Prices will have to have gone up by another 13% to even break even compared to renting, considering the 6% cost of transaction when selling a house.
It simply does not make sense to buy in this housing market. With shacks in the Richmond 'hood going for $300k, I'm going to stick with renting. For others considering buying, in other markets, use the spreadsheet yourself.
[1] An important note: I do not consider asset appreciation in the model. When there is such a feeling of speculative bubble, I don't want to include speculative gains in the calculation. But I do assume, by considering the money paid to principle as savings, that the value won't drop below the down payment.
[2] Two other factors I'm also excluding: the complexes considered are in Richmond California (a truely atrocious school district) and are built on bay fill. In the event of a major earthquake, every dwelling in the area is going to be red tagged. As a renter, that just means I need to move my stuff. If I was an owner, even with insurance, its a catastrophe.
Export License Required to Log In...
The Commerce Department, in the Federal Register, has proposed some significant changes to the Export Control Rules. The changes seem subtle and arcane (a change of 'and' to 'or', changing country of citizenship to country of birth OR citizenship (whichever is more restrictive), and a couple of "clarifications"). But the implications appear huge, especially the 'and' to 'or' change. Assuming I'm reading this correctly, it sounds like whoever allows a foreign citizen to use a supercomputer (or other export controlled device) has to get an export license and approval from the federal government. And just about every remotely decent cluster qualifies. Will universities be forced to deny access to Chinese graduate students? What if someone had the misfortune to be born in Iran? Or Cuba? It's not too late to submit comments (mail to scook@bis.doc.gov, with "RIN 0694-AD29" in the subject line), as the comment period extends until May 27th.
For export purposes, a "Supercomputer" is a system capable of 190,000 MTOPS (Million Theoretical Operations Per Second). The definition generally includes clusters of systems, not just individual computers. As the MTOPS is basically any instruction, at the maximum theoretical peak of every functional unit running as efficiently as possible, a normal computer actually scores very high. AMD conveniently publishes theses values, so a Dual Processor Opteron 248 is 15,000 MTOPS. Thus a cluster of only 13 $3000 Sun Fire v20z would be called a supercomputer and subject to US export controls. A computer lab where users can submit jobs to multiple systems simultaneously might also qualify.
Note, I initally saw this elsewhere today (I don't remember where), but I decided to actually look at the proposed rule. Yes, it is this scary.
For export purposes, a "Supercomputer" is a system capable of 190,000 MTOPS (Million Theoretical Operations Per Second). The definition generally includes clusters of systems, not just individual computers. As the MTOPS is basically any instruction, at the maximum theoretical peak of every functional unit running as efficiently as possible, a normal computer actually scores very high. AMD conveniently publishes theses values, so a Dual Processor Opteron 248 is 15,000 MTOPS. Thus a cluster of only 13 $3000 Sun Fire v20z would be called a supercomputer and subject to US export controls. A computer lab where users can submit jobs to multiple systems simultaneously might also qualify.
Note, I initally saw this elsewhere today (I don't remember where), but I decided to actually look at the proposed rule. Yes, it is this scary.
Sunday, May 01, 2005
Introduction
I figure that I'm enough of an egomaniac that I finally should start up a blog. After all, it is only academics with LARGE egos which should be blogging... This is not really very active yet, but I expect to use it in the future to post original items.
For background, my research area is computer security and computer architecture. I received my Ph. D. from UC Berkeley in the fall of 2003, and since then I've been a researcher at the International Computer Science Institute (ICSI).
This blog, however, will also include my thoughts on random topics of which I am completely unqualified as well as information on computer architecture and security topics.
For background, my research area is computer security and computer architecture. I received my Ph. D. from UC Berkeley in the fall of 2003, and since then I've been a researcher at the International Computer Science Institute (ICSI).
This blog, however, will also include my thoughts on random topics of which I am completely unqualified as well as information on computer architecture and security topics.
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