Get Out of a High Cost Area

You probably know that coastal cities are expensive. Actually, if  you’re reading this blog, chances are better than not you’re an educated person living in an urban area. It’s also not surprising that the high cost of living serves as a wall that prevents the migration of poor workers from e.g. Ohio or West Virginia. Interstate mobility in the US has decreased, and part of that can undoubtedly be explained by pull (family ties) and push (cost of living) factors. This has contributed to political polarization, overall wage stagnation, class-based segregation, and increased resentment all over the board.

The key tenet in my book is that wages are not going up, at least not as fast as cost of living. This article makes it abundantly clear that it’s driven by housing:

Housing costs have grown much faster in high-income places than low-income ones since 1960. Housing has always been more expensive in high-income places, but the difference is getting more extreme. In 1960, on average, US states with 10% higher incomes had housing costs that were 10% higher. In 2010, states with 10% higher incomes had 20% higher housing costs.

I would also add labour to that mix. As part of overall price pressures, you have to pay more for help, since they need to be able to afford to live there or otherwise be compensated for a long commute in from the exurbs.

So if you’re living in an expensive city, carefully examine your own life and entertain the notion that you may have more disposable net income after moving to the sticks. (Note: this doesn’t factor in the potential for career advancement and networking opportunities in the big city)

Better yet, take advantage of geographic arbitrage using techniques from my book.

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To Make Money in Real Estate, Follow Millennials

One big theme I harp on is that the new demographic bulge of millennials reaching adulthood (their peak spending years) will drive the success or failure of companies. Those who can adapt and cater to changing tastes stand to do well, while other who fail or cling to dying cohorts will be relegated to the dustbins of history.

Real estate has been one of the things on my mind in recent days, and it is without a doubt that millennials are influencing how future communities and properties are designed. Take this for instance:

“What millennials want are places that have a vibrancy, where you … can shop, go out to bars, walk, and bike,” says Lynn Richards, president and CEO of the Congress for the New Urbanism, a Chicago-based advocacy group for more pedestrian-friendly neighborhoods.

(…)

“For a very long time we built up our towns and villages and cities to drive” in, says transportation consultant David Fields with San Francisco–based Nelson/Nygaard Consulting Associates, adding that even drivers like to park their cars and walk around. “People ultimately want choice.” He says demand for biking-accessible communities is currently the highest he has ever seen.

Developers are taking note. Communities in the suburbs that chose to design for driving (I’m looking at you, Orange County) will suffer in the future as the new generations choose to live in walkable high-density places with plenty of amenities. This means that forward-looking cities like Portland, Denver, Austin, and Vancouver will reap the rewards (and they are, in terms of skyrocketing real estate prices)

As the article notes:

Developers and builders are taking note. They are offering bike storage facilities, valet, repair service, and even wash stations in fancy apartment and condo buildings to lure younger buyers and renters.

Crescent Communities, which builds subdivisions, homes, and apartment buildings across the Southeast, looks for cities and towns whose streets are lined with sidewalks and dedicated bike paths.

That’s because the No. 1 thing potential buyers of all ages want in their communities is walkability, the builder learned through surveys it conducts regularly. So Crescent looks for communities that already have those amenities in place to which it can link up its new buildings and developments.

While those hot areas are already expensive now, they may still have room to grow. What’s more rewarding is to look for communities that are still relatively affordable but which have the potential to be the next “hot” city where millennials flock to. I like to look for college towns close to large cities with good public transportation, a fun pub culture, and close to the outdoors (or at least with biking trails and green spaces).

Some potentials:

  • Fort Collins, CO
  • Madison, WI
  • Asheville, NC
  • Salt Lake City, UT
  • Bend, OR
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Priced Out of Housing

While I recently published a post on housing, that was a more general look at the concept of holding a mortgage in the first place. This post will be more on the specifics of housing conditions in urban centers throughout the US. Namely, things have gotten increasingly unaffordable for middle class people in desirable cities.

Take this article, for example:

The median home value in San Francisco now stands at $765,700 – 10 times the city’s median household income, according to the census. As of March, the median rent for a one-bedroom apartment was $3,590 a month. With the median income in the city being $78,400 a year, this means the average household can end up spending as much as half its earnings on housing.

It’s gotten to the point where the city core will be filled with the wealthy, while the ordinary workers, teachers, nurses, and police officers have to commute in from miles away. That takes an incredible toll, both physically and financially.

Will things continue to trend this way? Central London has shown us that prices can remain out of reach for decades, if not generations, when houses become used as investment assets for the global wealthy rather than as places to live. Central banks by lowering interest rates drives hot money chasing returns into real estate. While mortages are lower, houses are not any more affordable given how much prices have risen.

New construction isn’t going to come galloping in like a white knight to rescue us. For one, since the last crash construction has shut down and is only starting to slowly return now, but not nearly at the pace needed to keep up with new household formation.

Currently, things maintain themselves at an equilibrium, albeit stretched at near breaking point. Ordinary adult workers shack up two or three to a house in order to live in the city.

What’s the solution? Cities have to look at becoming denser with better utilization of space, overriding objections of the NIMBY anti-density crowd. Simply raising wages without increasing construction won’t work – there will be more money chasing the same tight supply, which will result in even higher prices.

There are some nifty things that governments can do to alleviate the shortage by discouraging investors from buying and removing housing stock from the rental pool. This is more of a problem in the UK, where property taxes are low, as compared to the US, where it would be costly for a foreign magnate to let too many houses sit empty.

But these are all things out of our control that may or may not end up happening. What we can do as individuals is to vote with our feet and move to places that are still affordable, such as Salt Lake City, Dallas, and Atlanta. Envisioning life outside of the country can work as well, especially for those who have read my book on wealth and are interested in a mobile freelance life.

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Save on a House with Seasonal Buying

Are you in the market for a house? If so, it’s important to be aware of seasonal variations. In my book on wealth, I discuss how time shifting purchases and activities outside of peak areas can lead to significant savings. In the case of buying a house, this means buying in wintertime.

Take a look at the following graph from Schwab:

seasonal fluctuation of house prices

If you look at the blue line, you’ll see that while the overall trend since 2012 is rising house prices, within each year there there are predictable ups and downs. House prices are highest during the summer months, and correspondingly hit a nadir in December-January. This makes sense. Fewer people are actively shopping for homes in the winter, given adverse weather.

Even though this trend is well-documented, a smart shopper can still use this as an opportunity to save on buying a house. The big downside is that sellers know about this trend as well and delay putting the houses on the market until summer. This means that the selection in winter may be suboptimal. You may not find your perfect dream house in the winter, but the sellers that do list in this time may be more desperate for a quick sale.

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Is Buying a Home Overrated?

Famed economist Alex Tabarrok certainly seems to think so. He cites a few reasons for why housing may not pay off as an investment:

  1. Significant concentration of wealth in a single asset
  2. Locking one in place geographically
  3. Sentimental attachment (preventing more rational choices regarding when and how much to sell)
  4. Historically appreciating less than the stock market

These are generally true, and I cite in my book all of these factors as caveats for any buyer to be aware of when considering a house. Indeed, a house is more than a place to live – it’s a complex investment at the same time, even after the mortgage has been paid. Choosing to buy poorly can lead to being underwater, unable to sell, and unable to move.

What Tabarrok neglects to mention is that the quirk of leverage allows us to dramatically increase our profit in the first few years. The government also subsidizes housing by making mortgage interest payments deductible from one’s taxes.

In terms of comparing housing to stocks purely in terms of financial payoff, let’s crunch the numbers with a bunch of assumptions. In general, a house rises slower but with less volatility and less significant drops in price as compared to stocks. So we can assume that our property value increases by 10% each year, while our rental yield is 6% of the total property price. Reserve 2% of the house value for expenses that arise (interest payment, property tax, advertising, maintenance). Here’s what it would look like, assuming a base $200,000 starting price and 20% down payment:

Year House Value Yearly Rent Yearly Expenses Total Equity % Equity Yield on Equity
1 $200,000 $12,000 $4,000 $40,000 20.0% 30.0%
2 $220,000 $13,200 $4,400 $56,000 25.5% 23.6%
3 $242,000 $14,520 $4,840 $73,600 30.4% 19.7%
4 $266,200 $15,972 $5,324 $92,960 34.9% 17.2%
5 $292,820 $17,569 $5,856 $114,256 39.0% 15.4%
6 $322,102 $19,326 $6,442 $137,682 42.7% 14.0%
7 $354,312 $21,259 $7,086 $163,450 46.1% 13.0%
8 $389,743 $23,385 $7,795 $191,795 49.2% 12.2%
9 $428,718 $25,723 $8,574 $222,974 52.0% 11.5%
10 $471,590 $28,295 $9,432 $257,272 54.6% 11.0%
11 $518,748 $31,125 $10,375 $294,999 56.9% 10.6%
12 $570,623 $34,237 $11,412 $336,499 59.0% 10.2%
13 $627,686 $37,661 $12,554 $382,149 60.9% 9.9%
14 $690,454 $41,427 $13,809 $432,363 62.6% 9.6%
15 $759,500 $45,570 $15,190 $487,600 64.2% 9.3%
16 $835,450 $50,127 $16,709 $548,360 65.6% 9.1%
17 $918,995 $55,140 $18,380 $615,196 66.9% 9.0%
18 $1,010,894 $60,654 $20,218 $688,715 68.1% 8.8%
19 $1,111,983 $66,719 $22,240 $769,587 69.2% 8.7%
20 $1,223,182 $73,391 $24,464 $858,545 70.2% 8.5%
21 $1,345,500 $80,730 $26,910 $956,400 71.1% 8.4%
22 $1,480,050 $88,803 $29,601 $1,064,040 71.9% 8.3%
23 $1,628,055 $97,683 $32,561 $1,182,444 72.6% 8.3%
24 $1,790,860 $107,452 $35,817 $1,312,688 73.3% 8.2%
25 $1,969,947 $118,197 $39,399 $1,455,957 73.9% 8.1%
26 $2,166,941 $130,016 $43,339 $1,613,553 74.5% 8.1%
27 $2,383,635 $143,018 $47,673 $1,786,908 75.0% 8.0%
28 $2,621,999 $157,320 $52,440 $1,977,599 75.4% 8.0%
29 $2,884,199 $173,052 $57,684 $2,187,359 75.8% 7.9%
30 $3,172,619 $190,357 $63,452 $2,418,095 76.2% 7.9%

 

Most of the data, if plotted, would look linear, as we’d expect given our fixed assumptions. However, I’d like to draw your attention to the last column – yield on equity – which is the annual rental income divided by our total equity. This is where leverage comes in and amplifies our gains. Normally a business generating $12,000 per year in gross yearly income (or $8,000 net) would cost more than $40,000 to buy, but we were able to finance it with a mortgage. As we plow our profits back into paying off the mortgage, we build our equity. This happens very rapidly in the first few years, and tapers off over time approaching the 6% yield, as our equity approaches 100%.

Visually, we can plot the exponential rise in equity in the first few years:

equity over time

This is why some house flippers sell the house after a few years, when the bulk of the equity accumulation has happened. They then take the profits and split that into buying 2-3 houses, starting the leverage process all over again from the beginning and benefiting from a 20-30% yearly increase in wealth into perpetuity. This rate just about doubles stocks’ average yearly gains.

Banking on leveraged gains like this can pay off handsomely, but it can backfire if prices drop rapidly. This is why this strategy can only be used on a (mostly) stable income generating asset like housing, where prices and rents rise slowly but surely.

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When Housing Becomes Unaffordable

A friend recently sent me an article detailing how Seattle has a major homeless problem (with the accompanying scourges of drug use, violence, and property crimes). It’s definitely sad to see. I’m intimately familiar with the growing 21th century phenomenon of unaffordable housing, having grown up in the SF Bay Area, which dealt with these issues decades before Seattle (and Portland). Realistically, I anticipate that the forces driving unaffordability will only get worse over time. Real estate in downtown cores of desirable cities, like Seattle, San Francisco, Vancouver, and London, is priced as an investment asset rather than a place for locals to live. There’s just no way middle class workers can compete with large pensions, hedge funds, sovereign wealth funds, and billionaire tycoons for property.

What can we do? Certainly economists have developed ways to combat homelessness through subsidies and affordable housing mandates. Others seek to curb foreign investment in housing or extract large taxes from absentee/nonresident homeowners. Those strategies will only go so far if we don’t address the fundamental issues of inequality. There’s simply too much wealth sloshing around looking for things to invest in. Nevertheless, I try to stay away from politics on this blog, instead preferring to approach things from an microeconomic perspective. As individuals, we’re unlikely to have much effect on changing things at a larger systems level, so all we can do is adapt, adjust, and try to survive.

How can we do that? Check out my book on wealth for tips on how to make enough money to buy that expensive house, how to structure the mortgage, as well as learn lifehacking tricks for how to compensate for expensive housing.

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