NYC Apartment Buy vs. Rent Discussion (fka Yo, Ohai!)

As an aspiring BSD who is looking at potentially buying property in Manhattan, I figured I’d ask an actual BSD who has, I’m sure, properly analyzed the buy vs. rent dilemma. I was planning on building my own model but then stumbled on the NYT model below which has most of the variables I was planning on implementing myself.

Obviously, the ultimate decision on buy vs. rent is heavily dependent upon the assumptions you put in for home price appreciation and investment return rate.

Does anyone have any thoughts or perhaps other variables to consider which are not covered by the NYT calculator?

https://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html

The NY Times calculator is pretty accurate and comprehensive from my experience. I do have my own model in Excel, and I used it to model probably over 100 different listings during 2016. My model tends to be just slightly more aggressive (more likely to recommend Buy) than NY Times’, for some reason that I never figured out. So, it would probably be better to use the more conservative model if this ends up being the case for you. In fact, my wife almost killed me after we looked at so many places for my research, only for me to conclude that I didn’t want to buy anything…

In terms of other variables - you can generally represent that in the NY Times model by adjusting some of the known inputs. For instance, you might have some co-op transfer cost or something, but you would just include that in Closing Costs.

What is not captured in NY Times is the scenario where you keep the property and rent it out later, rather than sell it when you move. This has a huge effect on the results. What makes the “Breakeven Time” analysis, as used in models like this, relevant is the very significant transaction costs of real estate. Given that you will lose 5% to 11% if you sell the property, your economics improve if you hold the property for a long time, since the benefits are amortized over that long time also. However, if you do not sell the property - ever - you save a large amount and the economics move in your favor. You would need to make your own model of cash flows to see how this scenario works for you - the sensitivity to opportunity cost will increase, since the holding period is longer.

Also, don’t take any numbers in your inputs at face value, since property owners have incentive to inflate numbers in their favor. For instance, if they say the rent of some apartment would be $5k, it’s usually lower than that, since many places provide incentives like free month rent to make the figures look good.

In addition, you should add some amount to the Breakeven years in the NY Time result to account for liquidity or mobility premium. If you are economic neutral at 5 years, for instance, it is better to rent, since you can leave at any time. Your money will presumably be in liquid investments like stocks, rather than an illiquid real estate asset. So, you can change your decision easily and with little cost. This option is worth a lot of money.

Anyway… I have lots of things to say about this, having spent 100s of hours looking into NY real estate for my own purposes. Probably is better if I don’t go off topic.

Thanks for the thoughts. I basically came away with the conclusion that it doesn’t really make sense to buy something unless you intend to hold it for a very long time.

Regarding the scenario in which you rent out instead of sell - agreed in theory, although rental yields are very low and it seems like a complete pain to deal with tenant turnover. Moreover, considering the tax benefit of having a mortgage is eliminated at over $1m of principal, unless you’re making crazy dough, you’ll likely want to sell that property to roll the equity into the new one to keep your mortgage balance at <=$1m.

From my case studies, I found that yields (after all cost) for buying a property for cash in NYC were 2% to 2.5% in 2016*, which is probably too low for someone with your risk tolerance. It’s really more for investors who would otherwise be holding bonds, or for foreign people who want to hold some USD asset. You can potentially hire a realtor to manage your tenants (many people do, especially the foreign owners), but this will affect your returns. You can probably get 6% or more yield if you go into some sketchy neighborhood in Queens or somewhere else, but you’d have to deal with some other sorts of issues.

*You can probably expect higher returns in 2017, in theory, since interest rates are higher. That’s assuming that someone will fairly sell you a property for its intrinsically lower price this year, which is not necessarily a good assumption.

Now… there are some scenarios that make real estate investments more attractive. First, consider that you can defer capital gains tax indefinitely by rolling the liability into a new property every time you sell an old one (1030 rule or something). Second, if you own many properties and classify yourself as a “real estate professional” (which means you declare on your tax returns that you “spend a significant amount of time managing real estate” - no license required), you can offset rental income from one property with paper losses on another. This is useful in NY properties, since you will most likely declare a net loss after interest expenses and depreciation.

Anyway, like you, I decided that the many inconveniences made purchasing real estate relative to its alternatives. I’m just putting a few things here for the sake of discussion.

brahs, did you add to your models a binary input factor called “Does the wife want to live in a cute house you own - Y/N?” and put 95% or higher weight on it? just trying to help you calibrate your textbook analysis to the real world.

Yes, in fact, I think what saved me from divorce is my promise of providing an even cuter house at some point in the future. So, effectively, kicking the can down the road.

^ do you fill in a form for rule 1030 mentioned above or is it another document drafted by the lawyer?

Maintenance is the killer in Manhattan. Makes it difficult to get over the hurdle imo

It’s rule 1031 and yes, you should retain counsel for that type of transaction as it’s fairly involved and if you mess anything up in the process you risk triggering a taxable event.

2% yield on real estate = hacksaw, especially in NY where pricing is significantly correlated with equity market performance.

2% yield is prolly from a enterprise value perspective (with debt included). if you are looking at it from a cash outlay perspective that yield is definitely higher (10%+) imo at least in cali this is the case. also the 1030 rule is a way to defer taxes on gains, but you have to be quick to buy right after you sell: https://www.sapling.com/7754646/1030-exchange-real-estate

the best way to realize gains is to refinance/rent out. fees are roughly 1% of mortgage plus you get tax benefits.

the main draw in real estate is the leverage, the stable cash flow, and the stable prices.

No - mean with no debt. Let’s say you buy an apartment for $1.5 million cash and rent it for $5k a month. You pay maybe $2500 a month for maintenance and taxes, leaving a yield of $2500*12/$1.5 million = 2%.

There is virtually no unit in Manhattan that will be cash flow positive with less than say, 50% downpayment. This means you will probably have *negative* yield if you finance the property. “Investors” in such places are hoping that the 7% per annum price increases since 2012 will somehow last forever, and haphazardly build this into their economic decision.

As I mentioned, NYC apartments are a fixed income proxy for individual investors, leading to this yield that is comparable to bonds. At the time of my research, the yield on the US 10y Treasury was, let’s say 1.75%. Now that the 10y rate is about 2.4% and rents have not increased (they’ve probably decreased, in fact), one would expect that the $1.5 million unit mentioned above should now sell for significantly less than its original price.

Stable prices are a bit of an illusion, since property investors tend to be stubborn and “wait out” “soft” patches in the market. On the unit bought for $1.5 million above, if the owner now wants to sell it and intrinsically, the unit is now worth $1.3 million (a value that is derived from fundamentals and not observable market prices), the owner might list it for $1.55 million, assuming he deserves a gain, and just not transact for months, a year or more. Prices will not have gone down since no transaction was reported at a lower price, and listing prices have also not gone down. This is why it is extremely important to consider “volumes” of real estate transactions. Low volumes indicate that the market is priced higher than where it should be.

You could also ignore the market value and make a decision based on cash yield. However, as I mentioned, this tends to be unattractive in NYC, where yield are low or even negative.

huh? you’re telling me your buying at 2% unleveraged and you can get to 10% leveraged? are you leveraging at 250%???

you’re probably right that the risk profile is something closer to bonds, especially if you are unleveraged. You probably don’t have.much interruption of cash flow if you stay in line with market on your rent. but rents do go down in NYC, so that is a risk in any case i guaranty 75% of the amateurs that buy as an investment are under counting the amount of capex and deferred maintenance that will kill your return if you don’t do REALLY careful due diligence. Seems crowded to me, better places to put your money particularly if you’re in the finance industry and already have exposure to the equity market in more ways than one.

I disagree regarding equity and real estate correlation. In the event of a real crash, yes, all assets tend to be positively correlated. However, under normal conditions, there is very low correlation between equities and real estate. One could perhaps argue that Manhattan is a high end market and so, the ability of millionaires to afford apartments is related to their holdings of other assets including equity. However, historically, there is not much support for this argument.

not just holdings but income and bonuses. NYC and Orange County probably have the highest exposure to financial services and it has a definite correlation with the apartment market, no question. perhaps a bit less so after 2008 but still very significant.

well thats the key with real estate. you can get away with 5% to 20% as down payment. so you are essentially levered 20x to 5x your dp. 20% dp is pretty common.

Ok, but how are you going to achieve 10% yield through leverage, if unlevered yield is below your cost of borrow? That’s one of the main problem with buying investment properties in NYC at the moment - yields are so low that you cannot even be cash flow neutral unless you pay most of the price up front.

This discussion on NYC real estate worries me (as someone who follows people lending in the market). Do you think these are rational prices Ohai? I know NYC real estate has been a common short thesis over the last year, but I didn’t realize cap rates were 2%?!

of course they’re rational…until they’re not.