“It is hard to make money in real estate (a home) in the long run, unless there is unanticipated inflation (that is, inflation not impounded in the mortgage interest rate). A capital asset that appreciates at a 0.5% real annual rate…

…is almost entirely dependent on the income return, or rental equivalent, to make it competitive with stocks, bonds, and other assets.”, Cesar A. Orosco and Laurence B. Siegel, Excerpt from the Conclusion of “How Rare are Housing Bubbles? Understanding the Case-Shiller Index and Its Counterparts”, Advisor Perspectives, September 9, 2014

“Dear Cesar and Laurence:

This particular statement (from your otherwise outstanding article) has been bothering me. First, rental equivalent MUST be included in the cash flows and investment return, because everyone must live somewhere and pay market rents (if they don’t own a home). Second, even if “inflation is properly impounded in the mortgage interest rate”, you are wrong because mortgage interest is tax deductible, yet the capital gains from the nominal appreciation of a home are not taxable (up to $500,000 per couple or family every two years). In other words, even if inflation is properly impounded in say a 30-year fixed rate mortgage, this government-created “tax arbitrage” drives significant real returns for homeowners over time. (Somewhat counter-intuitively, the higher the combined federal, state, and local income tax rates of prospective homebuyers, the greater their tax arbitrage and the higher returns they earn from owning a home. Stated another way, up to the cap in mortgage interest allowed to be deducted, prospective homebuyers with higher combined income tax rates can pay more for a home and earn the same return as those with lower income tax rates. This partially explains higher home values in high income tax states like California.) Finally, nominal home price and imputed rent inflation does not seem to be “properly impounded” in rates for 15 and 30-year fixed rate mortgages. I am not an economist, but I believe this is primarily because mortgages (and the bonds derived from mortgages) are priced-to-a-yield based on the general rate of inflation in consumer prices, not on the specific nominal rate of inflation in home prices and rents, nationally or regionally. Respectfully, it is statements like the one above that have sparked my interest in building a model that will truly help prospective homeowners make more informed and objective financial decisions when deciding whether or not to buy a home, with a mortgage.  The bottom line is prospective homebuyers should understand what their likely, best, and worst-case returns on invested capital will be (over their planned investment horizon) if they buy a particular home.  That’s what institutional investors model when they buy real estate. Consumers should have nothing less.”, Mike Perry, former Chairman and CEO, IndyMac Bank

Posted on September 16, 2014, in Postings. Bookmark the permalink. Leave a comment.

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