Opinion

Felix Salmon

Rent-vs-buy calculation of the day, Nouriel Roubini edition

By Felix Salmon
December 17, 2010

Back in May, Nouriel Roubini held his book party at DBGB. He obviously likes the location, since in September he paid $5.5 million for the triplex penthouse upstairs. (EV Grieve has the photos of what is now the most expensive apartment ever sold in the East Village.)

It’s an interesting move, given what Roubini said back in 2006:

I’m bearish on the city. I live in Tribeca in a nice loft, and in four years, it’s increased 150 percent in value. That price appreciation doesn’t make sense. Now there are maybe twenty developments under construction in my neighborhood that are going to come to market in the next year. There’s going to be a huge glut. I see demand falling and supply going sharply up. So you’re going to see some pretty nasty price action…

It’s not as if there’s infinite wealth. There are thousands of new luxury units coming on the market, and the question is, who will buy them? If people start losing jobs, who can afford to pay 2, 3, 4, 5 million dollars?

Before it was sold, the apartment was offered for rent at $25,000 a month, which means we can plug the various numbers into the great NYT rent-vs-buy calculator. Roubini put down $2.5 million and took out a $3 million mortgage; I’m assuming he got a mortgage rate of 4.5%, that he can get a long-term return of 4% on his investments, that long-term inflation is 2%, and that his marginal tax rate is 40%.

Let’s say that Roubini is neither bullish nor bearish, and reckons that neither the price of the apartment nor the cost to rent it will change, going forwards. In that case, he seems to have made a bad decision:

001.tiff

(Incidentally, this assumes that common charges are $1,240 a month, which seems cheap to me; I reckon that in reality they’re likely to rise over time.)

If home prices have the “nasty fall” that Roubini predicted in 2006, things get much worse, of course. Let’s say they go down by 2% a year on average. In that case, even if the rent goes up by 1% a year, it’s still better to rent than to buy.

002.tiff

Basically, in order to make buying this place make economic sense over a 5-10 year time horizon, you need to be pretty bullish over the long term:

003.tiff

Of course, I’m sure that non-economic considerations came into play here. But if Roubini thought that the very idea of $5 million apartments is ludicrous and unsustainable, and that the value of this place is likely to fall by a seven-figure sum over the medium term, I can’t imagine that he would have made the decision to pay $5.5 million for it.

Comments
18 comments so far | RSS Comments RSS

I can’t imagine that it is ever rational to pay 18x the annual rent for a home, unless that rent is expected to rise substantially in the near future. (Would you pay a P/E of 18 for a stock whose earnings were expected to merely track the overall GDP?)

Then again, every aspect of the NYC housing market seems insane.

Posted by TFF | Report as abusive
 

Is the average annual appreciation the real or the nominal price increase?

Posted by MitchW | Report as abusive
 

what are your inflation assumptions?

Posted by q_is_too_short | Report as abusive
 

Would you pay a P/E of 18 for a stock whose earnings were expected to merely track the overall GDP???

Do you get to stay in this stock, or you still have to pay rent?

Posted by gk1652 | Report as abusive
 

It seems to me that any economic rational argument over rent/buy would need to include a few more factors:
1. Is the person’s income variability high/low? (Tenured Teacher v. Salesperson)
2. Is the person’s location variability high/low? (Again, tenured teachers rarely “need” to move for job purposes. Alternatively, an exec in the high-tech field may change cities regularly?)
3. When will a person’s income stream end? If someone is going to retire and face a “fixed income,” they may want to reduce cash flow variability by owning rather than renting? Indeed a paid off mortgage can dramatically reduce the cash flow “needs” of a retiree.
4. Uniqueness: Regardless of the economics, people enjoy “unique” things and are willing to pay a premium for owning them. If that apartment has a unique quality that has a value to him, buying it may add to his enjoyment of the property.

Simply put, if he feels that he will be in that apartment for 15+ years b/c he isn’t likely to leave NYC, buying is probably a decent idea. Any short term reduction in the value of the apartment will never be felt. As for long term prospects, his enjoyment of “that apartment” probably has enough value to him to make up for any investment losses he might have.

Posted by UnclesFester | Report as abusive
 

Well put, UnclesFester.

In the first six years of our marriage, we lived in four different apartments. (Two of the moves were essentially forced, the third was a relocation.) Since owning, we’ve lived in one place for ten years. Nice that we no longer have landlords forcing us to move (or jacking up the rent).

Posted by TFF | Report as abusive
 

I honestly think that this is just Nouriel’s Iranian heritage. We just love to own property. It’s his animal spirit if you like. Way to go playboy! Big Pimpin Spendin Gs!

Posted by DCDMQ | Report as abusive
 

The one consideration that is ALWAYS ignored on this topic is what the renter does with the difference between their cheap rent and my expensive ownership.

If you have the mental discipline to invest the difference each month than I agree with you that you will be better off by far renting than owning in the current enviroment. That’s shocking given the massive subsidies doled out to homeowners.

The issue I have is that the financial pros fail to take into account that Americans (generally) and American renters (MUCH LESS generally) are among the LEAST disiplined people on Earth. As evidenced review our recent political exercise in the deficit comission saying to increase taxation and lower spending and democrats and rebublicans who can’t stand each other could agree on one thing TO DO THE OPPOSITE. Slash taxes and increase spending!

Most people I know would be better off buying a home if it depreciated at 2% annually in perpatuity because at the end of 30 years at least they’d have something. At the end of 30 years of renting you still owe the next months rent.

Do you see the difference there… In one case you made a bad investment that lost money every year for 30 years and you OWN SOMETHING worth much much less than you paid for it. You’re really dumb!

In the other case you made no investment and you OWN NOTHING AT ALL.

Both are bad… which is worse?

Posted by y2kurtus | Report as abusive
 

Probably Roubini is hedging against a dive in the value of the USD. If it goes down vis-a-vis the Euro or Yuan (which he often gets paid in, presumably) his mortgage payment goes down, taxes go down, etc.

Most Americans don’t earn a substantial chunk of their income in other currencies. We don’t think like Roubini the Great.

Posted by LadyGodiva | Report as abusive
 

I dunno, y2kurtus, but I keep coming back to one inescapable fact…

For an investment of 10x to 12x the equivalent rent we secured a supply of housing that has met our needs very well over the last decade and is likely to continue to meet them well for the next 10-15 years. The choice made sense with a 6% mortgage and made even more sense after refinancing. It will look even better when the mortgage is paid off fully in a few years and we can put the cash flow to work in other ways.

Posted by TFF | Report as abusive
 

Hate to nitpick but as an East village resident, his apartment is not upstairs but down the block. DBGB is in a big new glassy building but it’s not a condo, it’s a rental. The condo is a few doors down on 1st street.

that said, let us welcome Roubinin to the neighborhood; his politics, attitude and intelligence will fit right in.

Posted by Eastvillagechic | Report as abusive
 

@y2kurtus, you’re talking about this, I think:

http://www.felixsalmon.com/2007/03/rent- vs-buy-redux-is-buying-a-useful-commitme nt-device/

I don’t think it applies to Nouriel, because he earns much more than he spends anyway.

@LadyGodiva, if the USD goes down, his rent would go down in euro or yuan equally. It doesn’t affect the rent-vs-buy calculation.

Posted by FelixSalmon | Report as abusive
 

Felix –

To take Lady Godiva’s thought a bit further, consider if a generalized inflation across currencies. It didn’t take any crisis at all to get us to QE2. By currency fixing, China is matching us at every step, and they have major inflation. It seems like only a matter of time before their inflation is exported to us.

If we have substantial inflation ahead, its great to own. Methinks your inflation assumption of 2% is way too low, given the structural deficits around the world. The 2% figure is far below any historical averages even.

Posted by DanHess | Report as abusive
 

DanHess, we are in a naturally deflationary period while the Chinese are in a naturally inflationary period. QE2 and the other Fed actions may be boosting inflation by 3% to 5% right now, which (when added to the base tendency) would be the only thing keeping us out of the red. Added to the natural pressures in the Chinese economy, that same figure is pushing them into the high single digits.

This reminds me of the Cold War showdown with the Soviet Union under Reagan. The military buildup was costly for the US, but devastating for the Soviet economy. China’s economy is closer in scale to our own, however we still control the only printing presses that matter. Eventually they will have to concede and allow the yuan to appreciate against the dollar. (I would expect an appreciation of 50% or more over several years. A *huge* shift.)

And yes, I agree that 2% is way too low an estimate for inflation. I’ve been using 4% recently for my own long-term estimates. Of course I also use a 7% estimate for portfolio return (3% real return), which somewhat balances the equation.

Posted by TFF | Report as abusive
 

I think this trade’s a hedge against further USD debasement.

fyi, regular readers of CribChatter.com (dedicated to Chicago real estate) and SocketSite.com (SanFran real estate) know that when properties from those two cities are inputed into the NYT’s calculator it is NEVER better to buy instead of rent.

So I presume that means either rents will soon rise or prices will continue to fall.

But the Fed is doing everything it can to prevent asset values from falling further, just listen to Donald Kohn:

“I think our actions prevented an even more disastrous outcome,” said Donald L. Kohn, who was the Fed’s vice chairman during the crisis. Without the Fed’s help, he said, “liquidity would have dried up even more than it did, asset prices would have fallen even more than they did, and economic activity and employment would have fallen further and faster then they did.”

http://www.nytimes.com/2010/12/02/busine ss/economy/02fed.html

So don’t worry Nouriel — the Fed’s got your back & will protect you from any downside.

Posted by dedalus | Report as abusive
 

P/E of 18 isn’t bad when the costs of money is under 5%. Would be cheaper to buy than own in that case…if you forget about taxes, assessments, and maintanence.

This was probably a little pricey. I’d like it better at 14 to 1 at current rates.

Posted by sditulli | Report as abusive
 

I’ve been to his triplex. It’s a good deal for 5.5 million by NY standards. Better then paying 12 million for a Park Ave boring pad. I must say that it is far too big for a two person household.

Posted by worcester | Report as abusive
 

If you believe that the dollar will implode soon, what is a better investment then buying the most expensive house you can buy and take the largest mortgage you can get. In five years five million dollars will be just enough to buy a new car.

Posted by worcester | Report as abusive
 

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