Learn about Renting vs. buying a home - part 2 Video

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Learn about Renting vs. buying a home - part 2

Welcome back. I now want to play a little bit of Devil’s Advocate with my self. You know I made this argument where I show that for the exact end of cost if these are the numbers, and we have to work it out based on your market and what the numbers are of the time. But if this size is a comfortable rent for million dollar house, I showed you that for the million dollar house you’re burning $40,000 a year. This is not money that is going to be build equity. This is not money that is going to go the principal of your house. This is money that is going out of your pocket and you’ll never see again in a way and actually not in a way then reality you can view this $40,000.00 as rent on the money that you borrowed. Interest is nothing but rent. So when you have an asset, if the asset is cash, the rent on it is interest. If the asset is a house, the rent on it is your monthly rent payment. So when you think of it this way when people say “homeownership”, they’re really are not home owners yet. They’re not home owner until you do not have that, you are a money renter. So your choice is either to be a money renter here or to be house renter here and I’ll show that you’re burning almost double the money. But then there's the argument of whether there are advantageous still to buying this house and what are they? Well, one example is in this situation if I did get a fixed rate mortgage and we learned when we are looking at those adjustment rate mortgages we know that a lot people did it but if I have a fixed rate mortgage I know what my payment is for the foreseeable future, for the next 30 years. Well my landlord in this case, they could keep raising my rent. So this might look good right now but what if my landlord raises the rent to $3500.00 a month. Well then out of your pocket.5 x 12, you’ll be spending 42,000 a year and then of course you’ll get the interest from the money that you put on the bank minus ten. So in that case if the rent goes up and out of your pocket is 32,000 every year, right? Well what if the interest that you get on your cash on the bank goes down and this 10,000 will become lower. Well as we can see, the rent would have to go up a lot to make this a break-even situation. Let’s figure out how much it would have to go up. In this first scenario, in order for your net output for it would be 41,500. Assuming you’re getting 10,000 from the money in the bank, your rent would have to be 51,500. So it’s 51,500 because you have 10,000 from the bank and so divided by 12. Your rent would have to be $4300.00 in this situation to make this a break-even proposition and you could view it. I mean this another way to view it. If I were to buy the house and if I were to move, how much would I have to rent this house out for in order to not be losing money every month? Well, I would have to rent it out for $4300.00 a month even though maybe the market rents are at only 3000. And then whether there's another Devil’s Advocate argument, and this was something that you have heard a lot about three years ago, and a lot of these people are talking this much now. But then they would say, “Housing has done nothing but gone up and I will build equity just from housing appreciation”. So how much does my house have to appreciate ever year? Well to make up this difference 41,500-26, so to make up that 51,500 difference every year this is 15,500 favorable. My house would have to appreciate by a comfortable amount, right? So how much appreciation is done on my house? Well, that’s a million dollar house, right? So $15,500.00 appreciation in million house so I’m doing everything in thousands, so thousand, thousand is a million. But that’s only 1.5% appreciation. So if my house appreciates by 1.5%, that's it, 1.5% of house just depreciates by 1.5%. I’m going to make up this 15,550 and so it is worth it for me. It is worth it for me to blow this money by having kind of an increase or by renting the money for more than I will have to pay to rent the house and that might sound like a very reasonable proposition that the house will appreciate by 1.5% from 2001 to 2005, 2006 houses were appreciating like 10-15 percent a year. So a real estate agent will often do this very much with you. So you’re definitely getting 1.5% in fact you probably get 10% appreciation and you’re going to make much more than this. But think about what in the presentation of the balance sheet and leverage, what happens if housing prices go down by 1.5%? What happens if it’s minus 1.5%? Well then you’re going to be spent this much to rent the money, right and you’re not going to gain this much. You’re going lost this much every year and so the proposition becomes even worst. So this is a big deal. Now that you know, I think on nation wide basis a lot of the housing industries show that housing prices have gone down I think by 6%. That’s what the Case-Shiller index says, 6% a lot especially like a million dollar house that’s $60,000 a year that is evaporating. It’s wealth that someone thought they had that is just disappearing out of the equity. So this rationale of paying more to rent, the money for house than to rent the house is justified if housing prices go up. It becomes ten times worth when housing prices are flat or God forbid if housing prices actually go down. And now we see that housing prices actually go down in the last couple years especially in the areas where like the Bay Area or Florida or California especially on the Southern California where this is happening. And you know about even two or three years ago when people used to make this argument, people used to make the argument, “Well, you know my house just has to go up one or two percent and I’m going to make up the difference.” I’ll said, “Well, why is your house going to go up one or two percent?” I mean there has to be some reason why next year someone is willing to pay two percent more for that house? Is it because rents are going up two percent a year so the income stream is going to be two percent higher? And actually the Bay Area from 2001 to 2003 rents were going down, and there are actually people moving out, all the tech workforce were getting laid off. We have a lot of programming jobs being outsource to India and wherever else. So you have this whole situation where the population was actually decreasing where demand for housing was going down but for some reason housing prices were going up. So people said, “Well they’ve been going up for the last five year, so they will continue and they’ve never gone down etcetera, etcetera”. But it did make an economic argument. And I’ll show in the future video that the only reason why housing prices did go up is that just became easier and easier and easier to buy house, the standards that banks used for giving out the loan became lower and lower. There are actually examples in Southern California and in San Jose and some of the suburbs where people who had incomes of $30,000.00 or $40,000.00 a year, the bank actually gave them a million dollar loan to buy a million dollar house based on stated income. There are things called stated income loans or you’ll just tell the bank what you earn, you do not have to prove it to them. And so every year that went by just became easier, easier and easier, more and more people just thought that housing always appreciates so that’s why they want to pay more and more. They essentially rent the money for a house and just became a self-fulfilling prophecy but as we see on the way down it works completely against you. So in a situation where we are now where nationwide, housing prices are actually declining and actually they will decline until this rent versus buy equation starts to make a little bit more sense. It really hurts the home buyer. Now what's even worst and this is kind of adding insult to injury is that this guy once if I’d bought this house and all of the sudden I lose my job, and I cannot pay the house back, I might lose my entire $250,000 down payment because maybe I cannot sell the house or the house is selling for less. Or maybe I want to move and just there’s no one out there who can buy a house because the bank all of a sudden got smart again and realize that they should become more serious in terms of who to give money to. And so I’m just stuck holding this house and my flexibility in terms of where I can move is limited. Actually a friend of mine was selling it that they’ve actually done studies and there's correlation between unemployment and homeownership because when you own a home, you have less flexibility looking for a job. If I have a house in San Jose but there's a job in LA, I might not be able to take that job because I cannot sell my house or I might not even look for job in LA. While the renter of course, I could just, you know my lease ends and I leave. So this is just the rough sense of the rent versus buy and I know I get very impassioned about this but that’s because I explained this a lot and when I'm at parties and I start talking about the calculations people eyes rolled but I made this video now, and I’ll just tell people to watch it. See you on the next video.

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Welcome back. I now want to play a little bit of Devil’s Advocate with my self. You know I made this argument where I show that for the exact end of cost if these are the numbers, and we have to work it out based on your market and what the numbers are of the time.

But if this size is a comfortable rent for million dollar house, I showed you that for the million dollar house you’re burning $40,000 a year. This is not money that is going to be build equity. This is not money that is going to go the principal of your house. This is money that is going out of your pocket and you’ll never see again in a way and actually not in a way then reality you can view this $40,000.00 as rent on the money that you borrowed. Interest is nothing but rent.

So when you have an asset, if the asset is cash, the rent on it is interest. If the asset is a house, the rent on it is your monthly rent payment. So when you think of it this way when people say “homeownership”, they’re really are not home owners yet. They’re not home owner until you do not have that, you are a money renter. So your choice is either to be a money renter here or to be house renter here and I’ll show that you’re burning almost double the money. But then there's the argument of whether there are advantageous still to buying this house and what are they?

Well, one example is in this situation if I did get a fixed rate mortgage and we learned when we are looking at those adjustment rate mortgages we know that a lot people did it but if I have a fixed rate mortgage I know what my payment is for the foreseeable future, for the next 30 years. Well my landlord in this case, they could keep raising my rent.

So this might look good right now but what if my landlord raises the rent to $3500.00 a month. Well then out of your pocket.5 x 12, you’ll be spending 42,000 a year and then of course you’ll get the interest from the money that you put on the bank minus ten.

So in that case if the rent goes up and out of your pocket is 32,000 every year, right? Well what if the interest that you get on your cash on the bank goes down and this 10,000 will become lower. Well as we can see, the rent would have to go up a lot to make this a break-even situation. Let’s figure out how much it would have to go up.

In this first scenario, in order for your net output for it would be 41,500. Assuming you’re getting 10,000 from the money in the bank, your rent would have to be 51,500. So it’s 51,500 because you have 10,000 from the bank and so divided by 12. Your rent would have to be $4300.00 in this situation to make this a break-even proposition and you could view it. I mean this another way to view it. If I were to buy the house and if I were to move, how much would I have to rent this house out for in order to not be losing money every month? Well, I would have to rent it out for $4300.00 a month even though maybe the market rents are at only 3000.

And then whether there's another Devil’s Advocate argument, and this was something that you have heard a lot about three years ago, and a lot of these people are talking this much now. But then they would say, “Housing has done nothing but gone up and I will build equity just from housing appreciation”. So how much does my house have to appreciate ever year?

Well to make up this difference 41,500-26, so to make up that 51,500 difference every year this is 15,500 favorable. My house would have to appreciate by a comfortable amount, right? So how much appreciation is done on my house? Well, that’s a million dollar house, right? So $15,500.00 appreciation in million house so I’m doing everything in thousands, so thousand, thousand is a million.

But that’s only 1.5% appreciation. So if my house appreciates by 1.5%, that's it, 1.5% of house just depreciates by 1.5%. I’m going to make up this 15,550 and so it is worth it for me. It is worth it for me to blow this money by having kind of an increase or by renting the money for more than I will have to pay to rent the house and that might sound like a very reasonable proposition that the house will appreciate by 1.5% from 2001 to 2005, 2006 houses were appreciating like 10-15 percent a year.

So a real estate agent will often do this very much with you. So you’re definitely getting 1.5% in fact you probably get 10% appreciation and you’re going to make much more than this. But think about what in the presentation of the balance sheet and leverage, what happens if housing prices go down by 1.5%? What happens if it’s minus 1.5%? Well then you’re going to be spent this much to rent the money, right and you’re not going to gain this much. You’re going lost this much every year and so the proposition becomes even worst.

So this is a big deal. Now that you know, I think on nation wide basis a lot of the housing industries show that housing prices have gone down I think by 6%. That’s what the Case-Shiller index says, 6% a lot especially like a million dollar house that’s $60,000 a year that is evaporating. It’s wealth that someone thought they had that is just disappearing out of the equity. So this rationale of paying more to rent, the money for house than to rent the house is justified if housing prices go up. It becomes ten times worth when housing prices are flat or God forbid if housing prices actually go down.

And now we see that housing prices actually go down in the last couple years especially in the areas where like the Bay Area or Florida or California especially on the Southern California where this is happening. And you know about even two or three years ago when people used to make this argument, people used to make the argument, “Well, you know my house just has to go up one or two percent and I’m going to make up the difference.”

I’ll said, “Well, why is your house going to go up one or two percent?” I mean there has to be some reason why next year someone is willing to pay two percent more for that house? Is it because rents are going up two percent a year so the income stream is going to be two percent higher? And actually the Bay Area from 2001 to 2003 rents were going down, and there are actually people moving out, all the tech workforce were getting laid off. We have a lot of programming jobs being outsource to India and wherever else.

So you have this whole situation where the population was actually decreasing where demand for housing was going down but for some reason housing prices were going up. So people said, “Well they’ve been going up for the last five year, so they will continue and they’ve never gone down etcetera, etcetera”. But it did make an economic argument.

And I’ll show in the future video that the only reason why housing prices did go up is that just became easier and easier and easier to buy house, the standards that banks used for giving out the loan became lower and lower. There are actually examples in Southern California and in San Jose and some of the suburbs where people who had incomes of $30,000.00 or $40,000.00 a year, the bank actually gave them a million dollar loan to buy a million dollar house based on stated income. There are things called stated income loans or you’ll just tell the bank what you earn, you do not have to prove it to them.

And so every year that went by just became easier, easier and easier, more and more people just thought that housing always appreciates so that’s why they want to pay more and more. They essentially rent the money for a house and just became a self-fulfilling prophecy but as we see on the way down it works completely against you. So in a situation where we are now where nationwide, housing prices are actually declining and actually they will decline until this rent versus buy equation starts to make a little bit more sense. It really hurts the home buyer.

Now what's even worst and this is kind of adding insult to injury is that this guy once if I’d bought this house and all of the sudden I lose my job, and I cannot pay the house back, I might lose my entire $250,000 down payment because maybe I cannot sell the house or the house is selling for less. Or maybe I want to move and just there’s no one out there who can buy a house because the bank all of a sudden got smart again and realize that they should become more serious in terms of who to give money to.

And so I’m just stuck holding this house and my flexibility in terms of where I can move is limited. Actually a friend of mine was selling it that they’ve actually done studies and there's correlation between unemployment and homeownership because when you own a home, you have less flexibility looking for a job. If I have a house in San Jose but there's a job in LA, I might not be able to take that job because I cannot sell my house or I might not even look for job in LA. While the renter of course, I could just, you know my lease ends and I leave.

So this is just the rough sense of the rent versus buy and I know I get very impassioned about this but that’s because I explained this a lot and when I'm at parties and I start talking about the calculations people eyes rolled but I made this video now, and I’ll just tell people to watch it. See you on the next video.

Transcription by: Scribe4you Transcription Services