And people wonder why the honest Joe in this country is getting screwed.

How are ordinary couples expected to live amongst bozos that do this sort of stuff?

awaiting, I can certainly see why you would be a SELLER at 3%-4% caps, but why in the name of all that’s holy would you be a BUYER at those rates?

My buyer in April was shuffling 1031 exchange money to buy 273x rent. Prop 13 and all the rest, I couldn’t let that much money sit illiquid earning so little.

I wouldn’t buy anything that didn’t cap out close to 10%, and think opportunities to do so might present themselves in the coming rubble (and not just in Texahoma this time!).

For those wondering:

“Cap 10%” is annual rental income as a percentage of purchase price. Thus $10k/yr in rent ($830/mo) -> $100k purchase price.

“Rent multiple” is purchase price divided by monthly rental income. Thus $100k purchcase price rented at $830/mo -> 120x.

Both [identical] examples above are historically “decent” deals, not “great” deals. My personal example of 273x (cap of 4.4%) shows how in SoCal at least the gap twixt rent and own is 2:1.

Still, the original post is quite mistaken about several aspects of taxes and favorable treatment. The most glaring example being the presumption that only owners benefit from preferential policies.

Hey Cote,

Now you’ve wandered into some other territory here with “preferential policies”. Please explain.

Part of my background is in personal and small business tax issues and in personal property insurance. I’d be very interested in your take on how my original post is “quite mistaken”. Perhaps it would be easy for you to round up a few of those mistakes and report back?

BTW, you never responded back several months ago about our rental discussion of supply/demand vs. cost to carry.

Sorry I missed the rent v. own v. demand and comparative carrying costs discussion. Pls restart and I’ll try to keep up.

Anyway, the costs to own ultimately fall through to renters. Not perfectly, not quickly to be sure but eventually. One aspect of deductibility is to smooth out such variations. I remember one renter wondering why her rent went up $22 in Dec. I asked her if she voted. She said yes. I asked her if she voted for the property tax increase for her child’s school. She said yes. I asked her if I was allowed to vote. She said no, you live in a different district. I told her, exactly.

Robert Coté said…

Anyway, the costs to own ultimately fall through to renters. Not perfectly, not quickly to be sure but eventually. One aspect of deductibility is to smooth out such variations. I remember one renter wondering why her rent went up $22 in Dec. I asked her if she voted. She said yes. I asked her if she voted for the property tax increase for her child’s school. She said yes. I asked her if I was allowed to vote. She said no, you live in a different district. I told her, exactly.

I still disagree in a short-term and medium term. The cost to own is only borne by renters when rental demand is near to rental stock. Because purchases of houses (even rental properties) are almost always financed, market externalities are only borne by the end consumer when they can be (this is econ 101). Luckily, when cost to maintain exceeds the market clearing price for quite a long time (as prices can be sticky), the lender often acts as a release valve. In this case, increasing defaults cause higher interest rates, which causes higher holding costs and lower profits.

According to the Zero Profit Theory of econ, with low barriers to entry, the total economic profit of all market participants will approach to zero over time. That theory is only ceteris paribus, but over the long-term you would expect that yes, it can be passed through.

In an environment with substantially more supply than demand, prices will not change if there is any level of economic profit left in the system after the change in costs is taken into consideration.

While the market does not operate in a vacuum, this is more or less how rentals work. In SoCal, there is most definitely economic profit available, but also tight supply relative to demand. Check out Dallas TX in recent past, if taxes go up, there is a direct correlation to rents; this is because although there is much more supply than demand, there is little if any economic profit. On the other hand, check out Endicott, NY for rental changes. Increases in taxes did not move rents because there is still economic profit in the system and substantial supply relative to demand.

awaiting, Sorry mate! I misread your post. I raise my glass to 10% cap rates here in SoCal in the next couple of years!

John Doe, you seem like you’d be a good teacher, but you sure don’t know much about reality!

Sorry kid, couldn’t resist!

Cheers.

Anonymous;

Keynes said it best. “In the long run, we are all dead.”

JD, why do I get the impression you have never been a landlord? I am not a landlord either having bailed in april of my last rental property. Prior to that however I had been a landlord of various and multiple properties for 20+ years. I will be a landlord again in a few years as well. Theories of Zero Profit are wholly irellevant to the reality of owning and renting.

Rational landlords optimze profits. That sometimes means temporary losses but on aggregate ALL costs are passed through plus profit.

said…
Robert Coté said…
JD, why do I get the impression you have never been a landlord? I am not a landlord either having bailed in april of my last rental property. Prior to that however I had been a landlord of various and multiple properties for 20+ years. I will be a landlord again in a few years as well. Theories of Zero Profit are wholly irellevant to the reality of owning and renting.

Robert, I don’t profess to know everything, but you need to reread my post. I was careful to point out that technically, it’s “zero economic profit” that I was discussing, not “zero accounting profit”. I highly recommend just taking a peek at wikipedia’s entry:
http://en.wikipedia.org/wiki/Economic_profit

This is very important and relevant because it introduces the concept of opportunity cost. I never said there would be zero profit, I stated that there would be zero ECONOMIC profit. This works not only in theory but in the real world.

Here’s a good excerpt: “Economic profit does not occur in perfect competition. Once risk is accounted for, long-lasting economic profit is thus viewed as an inefficiency caused by monopolies or some form of market failure.”

In the long run with normal competition and absent externalities, economic profit does go to zero. That’s not even to mention social profit which is an entirely different discussion but has enormous relevancy to Ventury County.

No, I have never been a landlord. Guilty as charged. That’s not my type of investment. No need to become antagonistic about it either. Just because someone doesn’t have your experience does not mean they cannot have a grasp of the concepts.

JD, are you ready to grant at least the very smallest; “yes, you are/were a landlord and yes I have never been a landlord” in this civil discussion? So far it seems I’ve called your experince corrctly and all you can reply is with “I don’t profess to know everything, but you need to reread my post.” Can you accept that I read your post and that is why I realized you had never been a landlord?

You also did mispeak. Not lie, not screw up, just typed something that doesn’t follow. You said as I quoted before: “Zero Profit .” I didn’t edit that but you tried to say you MEANT “zero economic profit” …not “zero accounting profit”. Fine. I accept the new revised description. Just don’t try to tell me that’s what you said previously.

That said the theory of what you now modify to call zero accounting profit is equally useless in the real world if the theory of zero accounting profit were true we’d still be trading the first fur for the first fishook for the first maize. Profit is what is left over after everyone benefits. Profit is not what keeps everyone from benefiting from progress.

Robert Coté said…
You also did mispeak. Not lie, not screw up, just typed something that doesn’t follow. You said as I quoted before: “Zero Profit .” I didn’t edit that but you tried to say you MEANT “zero economic profit” …not “zero accounting profit”. Fine. I accept the new revised description. Just don’t try to tell me that’s what you said previously.

Bullshit. I mentioned the word profit exactly 1 time in my first paragraph with a reference to “lower profits” Not zero profit. I didn’t mention that theory until my second paragraph. In the following paragraphs, I used the term “proft” exactly 6 times as follows:

1. “Zero Profit Theory of econ”
2. “total economic profit of all market participants”
3. “any level of economic profit left in the system”
4. “there is most definitely economic profit available”
5. “there is little if any economic profit”
6. “there is still economic profit in the system”

You most definitely did not read it correctly, as I was very clear to point out in every case that we were discussing economic profit, not accounting profit.

BTW, is no such thing as “Zero Accounting Profit Theory”. The Zero Profit Theory is also known as the “Zero-Profit Condition” You can look it up on wikipedia, or just search google to find numerous examples and explanations if that suits you, but in every case it is an economics discussion, never an accounting discussion.

Just as you believe it is difficult to have a discussion about tenants, rental cap rates, and the related, I assure you that I have at least an equally difficult time discussing economic theory with you.

The hardest thing to understand is why you won’t simply acknowledge that you made a mistake and misread my post. You rewriting my original posts doesn’t make sense because it’s within inches of your response. With me being as gracious as I could in my original post, yes, I granted you the smallest of pleasantries by admitting that I do not know everyting. But, I am certain I know the difference between economic theory and accounting. My masters’ thesis was written on the difference.

That said, both are useful in the “real world” as you term it. Those who deem something of no worth often do not understand it. It’s called casting pearls before swine.

JD claims: I was careful to point out that technically, it’s “zero economic profit” that I was discussing, not “zero accounting profit”.

The two terms in quotes above appear nowhere in the post.

JD claims: I mentioned the word profit exactly 1 time in my first paragraph with a reference to “lower profits” Not zero profit.

While the post does mention “lower profits” it also mentions in a 2nd reference to profits the following paragraph:

According to the Zero Profit Theory of econ, with low barriers to entry, the total economic profit of all market participants will approach to zero over time.
I definitely see the reference to “zero” profits in there. Zero was used. And this is where we disagree. The idea of total economic profit approaching zero is bunk. It flies in the face of every other practice of economic activity generating greater economic prosperity. I know better than to try to pretend I can hold my own in a discussion about economic theory. Not only am I not qualified
but JD is emminently qualified. Thus I return to what I know, those things I learned over decades of being a landlord. Costs plus pass through. Not perfectly, no immediately but ultimately (unless inhibited by things like rent control). Those profits are a greater good, they serve to induce people to become landlords and thus renters benefit from greater supply and quality. Same thing happens with incentives like tax benefits. They serve to keep rents down.

So, those are my two objections. 1. the claim that preferential policies don’t benefit renters and 2. that rental housing is a zero sum game.

Robert Coté said…
So, those are my two objections. 1. the claim that preferential policies don’t benefit renters and 2. that rental housing is a zero sum game.

This is the most bizzare and off-topic of your posts so far.

First, because there was no discussion of preferential policies not benefitting renters. I did, however, make the point that medium-term costs to own are lower for landlords than owner-users because of preferential tax policies. No discussion of renters there.

Second, because there was no mention of rental housing being a zero sum game. The point was that changing existing tax laws is a zero sum game. Taxes get paid one way or another; providing landlords with greater deductions than homeowners doesn’t favor homeownership for owner-users, but for landlords. This flies in the face of the “ownership society” for middle class americans.

As a final note…the concept of capitalizing words is lost on you. Zero Profit Theory is purposefully capitalized because it is a proper noun, with the significance that it is a formal theory, much like The Theory of Relativity, or the Law of Gravity. I added “of econ” to offer readers an insight to which field of study it applied to - a hint you clearly missed.

The idea of total economic profit approaching zero is bunk.

Why even comment on something you know nothing about? Without having even taken the time to read the information on economic profit, you profess to teach me about it? Come on, Robert, you’re smarter than that.

This is the most bizzare and off-topic of your posts so far.

That’s interesting since nearly half of my reply consisted of contradictory quotes from you. Here I thought we were disagreeing on the impacts of economic forces on rents and total cost of ownership with some forays into net benefits vs zero sum results. You tell me now these are off topic.

First, because there was no discussion of preferential policies not benefitting renters.

Sure there was. You said; “Most American’s aren’t aware that landlords get such a great tax break,…This is a zero-sum game where one winner creates a loser.”

This is plain wrong. Renters benefit secondhand. If the total cost of ownership goes up so does rent. If the total cost of ownership goes up supply goes down and rents go up again.

I did, however, make the point that medium-term costs to own are lower for landlords than owner-users because of preferential tax policies. No discussion of renters there.

You don’t consider rents as part of the equation when determining medium-term costs? Like I said, it is obvious that you heve never been a landlord.

Second, because there was no mention of rental housing being a zero sum game. The point was that changing existing tax laws is a zero sum game.

This is wrong on two accounts. Taxes are inextricably part of the total cost to own and thus impact rents. Second taxes are not zero sum policies. Tax something, get less of it, subsidize something and get more. We know what happens in this case with one of the most spectacular failures of tax policy in our history. When the Sainted Ronaldus Magnus allowed the Democratic Congress to repeal the tax deductibility of rental property construction. The negative impact on renters continues to this day.

Taxes get paid one way or another; providing landlords with greater deductions than homeowners doesn’t favor homeownership for owner-users, but for landlords. This flies in the face of the “ownership society” for middle class americans.

Unless you consider that it lowers the cost of renting and thus allows people to save for ownership.

As a final note…the concept of capitalizing words is lost on you. Zero Profit Theory is purposefully capitalized because it is a proper noun, with the significance that it is a formal theory, much like The Theory of Relativity, or the Law of Gravity. I added “of econ” to offer readers an insight to which field of study it applied to - a hint you clearly missed.

Not missed, dismissed. Capitalize Intelligent Design and I won’t pay it any more heed either.

RC: The idea of total economic profit approaching zero is bunk.

Why even comment on something you know nothing about? Without having even taken the time to read the information on economic profit, you profess to teach me about it? Come on, Robert, you’re smarter than that.

The theory has no practical application in the own/rent condition. There are significant barriers to entry. There also exist inital and ongoing skills necessary to be a successful landlord. Tax law does indeed muddle the difference twixt economic and accounting profit but does not change the fundamental transaction where renters eventually cover all costs.

Robert,

You missed the point entirely. No point in responding further.

JD

I thought I was responding quite accurately, using quotes and retaining context. My point is quite simple; if you make the cost of owning a rental property more expensive renters will bear the costs. Removing any of the favorable treatments as you suggest would do exactly this. Your ideas of changing tax law will in addition to making owning a rental property more expensive from a costs perspective alone will also make for fewer rental properties thus also raising prices to renters. Your conclusions are mistaken because they are based on the mistaken premise that this is a zero-sum game where one winner creates a loser. This is where you are incorrect. Lower costs lowers rents and increases supply which lowers rents which puts more money in renters pockets which encourages ownership. And more units regardless of owner/occupied or rented means a larger market supply which moderates prices also encouraging ownership. This is about as far from a zero sum game as is possible. Having done the rental income schedule of my 1040 every year for the last 26 years I know how the money flows, you don’t. Why won’t you accept my explanation of how the own to rent market really works? Oh, and if you need more help I’ll explain some of the misconceptions you have regards depreciation, deferal and what constitutes passive.

I’m not getting mad and I don’t respect you any less it is just this issue of pass through costs and zero sum where we disagree. I’m not going to lose any sleep if you refuse to accept my evidence but there really is no need to imply I’m not understanding your position and that it is due to my not being smart enough or careful enough reading.

Hey Robert,

No offense taken, but you need to really reread the post in the following context:

This was a discussion of cost of ownership between owner-users and owner-landlords.

It was never supposed to be a discussion of rent vs own. That was several months ago and we could debate that, but please not in this thread. I don’t disagree that costs will get passed from a landlord to a renter, but that is not a direct link because it assumes supply and demand in equilibrium from a supply standpoint.

The point was that legislators SAY that they favor homeownership, when they actually favor home renting. BTW, many economists (including myself) believe in a balanced rental market that the reduced cost of ownership for a landlord will be equally split between the renter and the landlord, supporting your theory of lower rents… but still, not part of the discussion.

Does this article impy that, as a home owner, i would be better off renting my neighbor’s indentical house (and vice versa), so that we each might take advantage of the depreciation?

Anonymous said…

Does this article impy that, as a home owner, i would be better off renting my neighbor’s indentical house (and vice versa), so that we each might take advantage of the depreciation?

You might infer that, but that’s not exactly the point.

However, if the conditions were right: you both bought identical homes at the same time, paid the same amount, plan on staying for the same amount of time and it’s less than 28 years, and charged equivalent rents, then, yes, that would be a likely inference.

However, the article was only pointing out why part-time real estate investing is so easy and attractive; it’s even cheaper than owning your own home.

Still doesn’t make sense (to me at least). If renting / investing in a home is cheaper than owning (and living in) it (in most if not all cases) then why would you need the host of conditions / requirements you put forth, which are unlikely at best? In other words, if it’s not cheaper for two people to swap homes (and rent the other person’s home) than it seems to me that home ownership has to be cheaper than renting?

Hi real estate pros.
I am a novice, I watched my parents manage several rent controlled buildings that they used to own, but I do not know today’s scenarios. Looking at prices, it seems as if it is impossible to pay the mortgage on the 8 unit buildings with the rents, the buildings seemed priced like individual luxury condos instead of fixer upper apartments in need of heavy maintenance.
Who is buying these and how do they make a profit at these prices? Is it all foreign money? Is there any pending legislation to stop foreigners from buying everything and inflating real estate so no americans can buy at the entry levels.