Friday, April 22, 2005

Rent-buy arbitrage

The analysis below of bay area rent-buy arbitrage is taken from Bay Area Housing Crash, where you can find much more information on the housing bubble. The author claims that recent reported sales price numbers are inflated and that prices have already started to decline in certain bay area markets.

"There are great tax advantages to owning." FALSE.

It is now much cheaper to rent a house in the San Francisco Bay Area than it is to own that same house. This is true even with the deductibility of mortgage interest figured in. It is possible to rent a good house for $1800/month. That same house would cost $600,000. Assume 6% interest ($3000 per month), $2000 closing costs, and a buyer loses $770 more per month buying than renting. Renting is a loss of course, but buying is a bigger loss.

Renting: Monthly Rent: $1,800.00

Property Tax: $400.00 ($625 per month at 1.25% before deduction, $400 lost after deduction)
Interest: $1,920.00 ($3000 per month at 6% before deduction, $1920 lost after deduction)
Other Costs: $250.00 (insurance, maintenance, etc)
Total: $2,570.00

Buyers still have to come up with the principal payment as well, just to watch it wiped out as the value of their house declines.

Remember that buyers don't deduct interest from income tax; they deduct interest from taxable income. Interest is paid in real pre-tax dollars that buyers suffered to earn. That money is really entirely gone, even if the buyer didn't pay income tax on those dollars before spending them.

Buyers do not get interest back at tax time. If a buyer gets an income tax refund, that's just because he overpaid his taxes, giving the government an interest-free loan. The rest of us are grateful.

Under current conditions, a renter would be able to live in a house for 30 years, then buy that house outright with the saved principle payments, and have an extra $277,200 of savings on top of that: ($770 x 12 x 30). The renter comes out way ahead of the owner, and this doesn't even count the huge losses the owner will suffer as housing falls year after year for the next decade or more, just as in Japan.

Another way to look at it is that except for the rich, everyone either rents a house or rents money to buy a house. To rent money is to take out a loan. A mortgage is a money-rental agreement. Owners with a mortgage seem to be renting their house from the bank, but there's an important difference. The bank takes no risk, the same as real renters take no risk. It's the owners who bear all the risk of falling house prices, and all the costs of repairs.


Anonymous said...

The bank takes no risk, the same as real renters take no risk. It's the owners who bear all the risk of falling house prices,...

This isn't true, is it? I thought if the mortgage principle becomes more valuable than the house, the owner can default on the mortgage.

alberthaanstra said...

Hi Blogger! Ik ben op zoek naar hypotheek Zou Afab echt zo goed zijn als iedereen beweert? Of kan ik beter zoiets als Geldshop proberen?

Groetjes Albert

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