Month: July 2014

Some thoughts on Home Ownership

A friend is thinking about buying a house in Maryland, so I decided to think about how the cost of ownership compares to renting.  There was a Washington Post article that I believe looked at this comparison between renting and owning for a townhouse in Arlington and concluded that they were basically the same.  Unfortunately, from what I recall, they neglected taxes, maintenance, etc.

Suppose you bought a new $300,000 townhouse in Maryland.   Let’s think about how much it may cost you (I use the calculators from bankrate.com).

 

Maintenance expenses:

These are usually estimated to be anywhere from 1-4% of the homes value per year.  So, let’s go with 1.5%.   That’s $4000/yr. 

Property tax:

State: 0.1%  $300

Montgomery County 1%  $3000

Waste disposal, Waste connection, etc: $500

Home Owner’s Insurance:  $650

Mortgage:

Let’s imagine that you put 20% down and you opt for a 30 year mortgage.   At 4.5%, that would correspond to about $1215/month, so that’s $14,580/year.

Let’s pause for a moment a tally what we have so far:

$23030/yr, or about $1920/month.

 

Now, usually people attempt to add in the fact that you can deduct the interest/property taxes on your income taxes.  Let’s see how much that saves you. The median income in Montgomery county is ~ $92,000/yr, so let’s round to $100000/yr to make the numbers easier.  Let’s further imagine that you are putting in enough payments to your 401K that you fall in the 25% tax bracket (Montgomery county would seem to charge 3.2% and the state 4.75%, so let’s assume that state tax is 8%).   Then you get to deduct ~$4100 the first year.  So at the end of the day, that puts you at about $18930/yr, or about $1580/month that you’re paying to own.  

 

So far, I have not included closing costs.  These are estimated at 2-5% of the home’s cost.   So, let’s assume you pay 3%, that’s $9000.  I checked with Bank of America website and the they estimate $11000, so let’s go with $10000.   I’m not sure what the best way is to add this to the calculation.   But, let’s say that you’re normal and hold on to the place for 7 years (it’s a bit complicated to predict this:  http://www.nahb.org/generic.aspx?genericContentID=110770&channelID=311).   So, you have to figure in the cost to sell your house after this of ~6% of the homes value.  Let’s neglect inflation (the value that I think a house should rise at in a sane market) $18,000,  So let’s add this to the closing costs and divide by 7 years to see what you paid per month.   This corresponds to about $333/month!!!   So, This put’s you back up to $1913/month to own.  Finally, throw in $100/month for Home Owner’s association fees and you’re at ~$2000/month to own.

Now, let’s look at rental prices.  If you want to rent a townhouse in the same county, you’re probably paying a comparable rate—perhaps even slightly more.   

So, the long and short of it is that unless I’m missing something terribly obvious, at the end of the day, it would seem that renting and buying are about the same in Md.   So, what are the pros and cons of one over the other?

Some people might argue that homes appreciate in value with time.  This doesn’t seem sane to me.   Over time, it seems like it should index to inflation.   A more detailed  analysis can be found on http://michaelbluejay.com/house/appreciation.html), but the basic idea is that if appreciation is greater than inflation, eventually nobody can buy a house.   This is in the best case scenario where salaries are indexed to inflation and even that doesn’t necessarily hold true...  

The other reason that a number of people give to suggest that home ownership is better than renting is the idea that you build equity in your house as you pay your mortgage, but with renting, you gain nothing.   However, this argument is a bit simple minded.   Your mortgage is front loaded, so initially, more of your payments go towards interest than towards the principal.   Also, that $70,000 (20% + closing costs) that you paid initially could have been invested instead.   Depending on your assumptions on the rate of returns, this could beat your accumulation of equity in your house (assume that you just get a boring index fund with low fees).

The downside of owning a home is that you simply aren’t flexible if you have to move for work.  Also, if you find yourself with a lowered income, it’s a fixed expense—a number of states, like Maryland, are “Recourse states", where if you are foreclosed upon, you’re still liable for the difference between the loan amount that you took out and what your lender was able to sell the house for.   Another danger of owning a home is the equity risk.  On the one hand, you could win the lottery and sell your home during a time where appreciation has favorably decoupled from inflation.  However, you could also have to sell during a housing bust when the value of the home is far less than what you initially paid for it (even without accounting for inflation), in which case, even if you’ve put equity into the home, if you sell it, you’ll lose money on the sale.  For example, suppose your home’s value drops to $250K.   You will have lost $50K when you sell, even if you’ve put equity in (of course, there are risks to investing as well).    The other risk  to home ownership comes from the fact that a number of states and municipalities have used creative accounting to balance their budgets.   However, at some point, to pay for expenses that they are obligated to (for example pensions) and to continue to provide services, they will have to increase their tax rates.  I would imagine that property taxes will have to go up as well.   

 

After thinking about this, I found:

http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html?_r=0

 

Which depending on assumptions, might be a a bit more optimistic about owning.  For them, using similar numbers would suggest that the cross over point is at around $1600/month.   This depends on your assumptions about the rate of returns on the down payment/closing costs money that you could have invested instead of using it to build equity in your home (along with assumptions on inflation/appreciation, rent increases, etc.).

 

So, the TL; DR is that the question of owning vs renting depends on your assumptions about the relative rates of return on investments and guesses about how appreciation and rent index to inflation.   It also depends on how long you are likely to be in the home and your tolerance to risk.   There are of course intangibles such as whether you want someone else to deal with maintenance or if you want more freedom to decorate.  For the scenario I described, it would seem to be owning by a nose, but it does carry the risks that I mentioned earlier.   So, on pure financial grounds, this doesn’t seem like it’s an obvious risk-adjusted choice to buy instead of renting.  

 

*This is for informational purposes only.  It is not investment advice and you should consult a professional if you want such advice.  I am also not a lawyer.  All opinions expressed are my own and not my employer’s.

 

Posted by william in finance

Some light martial arts fiction

On a friend’s recommendation, I just read, the CUHK Series: Fox Valant of the Snowy Mountain by Jin Yang. It starts with some interesting introductions and commentary by the translator (there was also an implication that these were written because the author needed cash...). I’m not sure if this is his only work that’s translated into English, or if this is the only one available on the Kindle. The first thing I noticed was the style of the language. While I’m sadly monolingual, I do have a reasonable command of the one language that I know--however, I found myself glad to read it on the Kindle, where I could look up definitions of words that have fallen out of common usage (or perhaps reflect a more British dialect of the language). I wonder if this was intentional on the translator’s part? Was the Chinese version colloquial, or does it also use an older tone of language. But after awhile, I became accustomed to it and began to enjoy it.

The other thing that I found was that there are a number of movies and novels which I’ve seen and read that owe a silent homage to this author. If you ever get a chance, Sean Russell’s “Brother Initiate” series has a very similar feeling to it. This particular story also has a familiar feeling with recent movies in which we’re told a story from different perspectives and gradually learn more about reality by viewing it from different angles. Here, it’s interesting that the characters we meet first turn out to be villains and it’s only as we meet other characters that we release that some of their opponents are actually the heros…Psychologically, it’s interesting because by introducing them first, we are initially biased in their favor.

One interesting question raised in the story is about the value and danger of pride. At times in my life, my pride has been useful and helped me to push forward despite opposition. But on other occasions, it has got me in trouble. Have you ever had the feeling of meeting the sky above the sky? To feel that you’re at the top of the game and then to meet someone stronger?

In the book, much is made of scrolls. In fact, one of the characters becomes a much stronger martial artist from reading a fragment of a scroll with the secret teachings of a school. But, is this plausible? I remember when I trained, I would read a number of books with pictures and they were useful, but not compared to videos. And even videos were not enough to capture the feelings behind a number of techniques. I think that a scroll could serve to mark ideas, but you’d really need to have a teacher to truly understand...

All in all, it was a good read. The only regret that I had was the open ending...

Posted by william in books, 0 comments

Uncontrolled!

I just finished reading Uncontrolled by Jim Manzi.  He starts the book spending a surprising amount of time in the early chapters of the book trying to give the reader a crash course in the philosophy of science.   The TL; DR is that I’m rather lucky to be a physicist.   The longer answer is that in the hard sciences such as physics and chemistry, we often have basic models of how the world work which we constantly test against new observations.   If we’re lucky, we find that our models don’t describe something in nature and that there is new science to discover.   But, at a deep level, we have a few articles of faith.   For example, we believe that the laws of physics don’t change from place to place.  We also believe that the laws of nature don’t change with time (even if our understanding of them does).   Other fields such as medicine are not so lucky.   We still have a very rudimentary understanding of the human body.  We don’t have strong enough models to say whether a given compound should cure a given disease.   There are also many confounding factors.   So, randomized trials are necessary to see whether the effects observed are intrinsic or accidental.   Even if a randomized trial indicates that an effect is present, it can be difficult to generalize it to a different context or population.   Sociology and economics are even more difficult.   The author brings up a number of cases in economics where authors have overreached and made predictions that really should have been tested in randomized experiments—otherwise, they are far too overreaching with too little support from data.

After this introduction, Manzi delves into perhaps the strongest section of the book where he outlines how he used randomized experiments in business to determine strategy.   When doing this, he looked into the literature of random trials in medicine, as well as random trials in social sciences (for example, leading up to welfare reform in the 90s, the federal government required a number of random trials for states which wanted to try different strategies.).  

There is another section of political trials, which reminded me of Rick Perry and His Eggheads and the better Get Out the Vote, which deal with experimental tests in politics of what strategies work and which don’t in get out the vote efforts.   

 

Perhaps the weakest section of the book is where the author attempts to make policy suggestions.   But overall, I would recommend reading this book.  If nothing else, it is helpful in increasing skepticism of predictions which lack experimental support.

Posted by william, 0 comments