March 8th, 2007

not-so-random commentary: ownin' a place, anywhere

Property taxes: you will be paying them. Now, in theory, you pay property taxes as a renter -- the person you rent from pays them and the theory is they get passed down to you. In practice, that's not entirely true. They may be willing to eat the taxes when the property is appreciating -- or if they can't rent it for any more than you are paying.

Let's consider the effects of the market on owning a place.

The premise of home ownership is that you gain control of your housing costs. This isn't true, of course, with some of these new-fangled loans where you get a choice of payments, but no sensible person takes one of those loans so I'm going to ignore them.

If you own the home outright, or have a straightforward fixed loan (whether 15 year, 30, or other) with no weird balloon payment down the line or readjusment of rates or whatever, the idea is that you can predict the size of your monthly payment for the duration of the loan, and after the home is paid off, you don't pay anything. In practice, there's that list I put together earlier of everything you have to pay when you own a place. I think most people recognize that over time, that list of stuff is likely to get bigger, rather than smaller, over time. We tend to expect that rate of increase to match the general rate of inflation, and, post-Reagan, we tend to expect the general rate of inflation to be quite low. These assumptions are not justified.

For example, heating oil costs and energy costs in general have recently demonstrated they can undergo substantial changes quite quickly.

As important, however, are property taxes. When you win a non-monetary prize (all expenses paid trip to Paris in the spring), you owe taxes on the value of that prize. This is sort of a problem if you don't have enough money to pay the taxes. And it can happen to homeowners. It's very nice to know that you can sell your home for more than you paid for it. Being able to borrow against that amount (home equity loans) can be very convenient. But when you pay taxes, you pay taxes based on the estimated current market value of your home. Every year, people are forced to sell their homes (which they can otherwise afford -- the fixed loan payment, the maintenance they do themselves or know how to hire affordably, the frugally used energy, etc.) because they can no longer afford the taxes on their home. Sure, they make a lot of money, but if they cannot afford to buy another home in range of their job -- or any job -- they may have just been forced out of home ownership entirely, putting them back at the mercy of the rental market, which prudent home ownership was supposed to get them out of.

Property taxes can vary widely from one location to another, and it's well worth investigating ahead of time. Once you are subject to them, your motivation to participate in the political process goes up substantially. Schools, fire and police protection are all funded entirely or in part by property taxes, which is why ballot measures involving those services are often a lot more contentious than seems justified to someone who has only rented in the past. In a locality that has numerous revenue streams (income tax, wealth tax, sales tax, property tax), this effect is somewhat muted. In a locality which gets the majority of its revenue from property tax, homeownership and the political process start to feel like a game of dodge 'em. Or chicken. Or whack a mole. Something violent and arbitrary, basically.

I have no simple advice on this subject. Forewarned isn't much ammo when you are up against this kind of avalanche. But you shouldn't go skiing in the backcountry not even aware that avalanches can happen. Find out what the taxes are on any place you are considering buying BEFORE you buy. Know that past taxes are a poor predictor of future taxes. Learn as much as you can about the local political landscape (upcoming bond measures, levies, etc.) as possible. Recognize that whenever your property becomes more valuable (yay!) your cost goes up (boo!) -- so once you buy, continue to pay some attention to the real estate market. Don't find out your place got worth more by realizing you're paying double taxes this year compared to last -- see it coming, so you can consider relocating to a cheaper place if it's going to be a big problem (or lobby for a cost of living adjustment at your job).

One last remark: if you think you have a Clever Plan for avoiding high property taxes, Watch Out! Everyone has already tried the Live in a Crappy Neighborhood and Live a Long Ways Out of Town strategies. Gentrification and sprawl eventually bring high taxes to you. One slightly less considered strategy is to buy into a nice neighborhood after the first wave of families' kids' have gone to college (everyone in the neighborhood is about to become grandparents). If you time it correctly, you'll have nice low schooling costs (as the district closes schools) and no major capital costs (everything has already been built). If you time it poorly, you'll buy in as all those people are moving into retirement communities/condos/assisted living, and another wave of families shows up and they start building schools again, or, worse, redoing the HVAC on old schools, which is a nightmare of unexpected cost overruns.

not-so-random comentary: home ownership, renting and investing

Quite a lot of books, articles and so forth have been written on the subject of buying-your-home as a nest egg. People actually spend a lot of time tweaking interest on loan vs. expected return in the market, expected appreciation of the home, what tax bracket you are in and so forth. Part of the push on the luxury end of the housing market is because some irresponsible people have summarized the investment in your home theory as buy-the-biggest-home-you-can-afford, which may or may not have ever been accurate for some definition of afford.

If you buy a basket of stocks like an index fund at an overall peak in the market, it can take quite a while for those stocks to recover their value, much less gain additional -- a decade or more. And most people don't have that kind of patience. In general, the transaction costs of selling a home (6% commission!, never mind what you have to do to prepare it for sale in terms of cleaning, getting the yard fixed up, repairing everything you let slide, "staging" it, and living somewhere else while you wait for it to sell, which seems to happen to a lot of people) are such that just breaking even requires about a 10% appreciation. This is raw truth behind the don't-buy-if-you-are-planning-on-moving-in-three-years advice. In reality, it can take many, many more years to get your money back.

If you live in commuting distance of a city like Boston or Seattle, or in Silicon Valley, it is impossible to imagine owning a home for a decade or more and _not_ making money when you sell. You just cannot find a decade where you'd lose. But this is not true for large blocks of the country (take northern Maine -- really! Take it! No one else wants it.). While it is hard to imagine a future in which commuting distance of Boston or Seattle or Silicon Valley is not in-demand . .. wait. No, actually, it's pretty easy to imagine a future in which commuting distance is not in demand. It's quite easy to imagine a future in which gas prices are so prohibitive everyone desperately moves as close to their job as they can, tolerating cramped conditions not seen since the 1950s.

One might conclude from this that living in the city is a great idea and can only go up. Yeah, you haven't been paying attention to how pessimistic this is, have you? That whole living-in-the-city thing is pretty recent. We've already had one or two major waves of new condo construction with ridiculous build quality problems. We've seen condos sell for a third their original value because of water problems.

Bottom line: the home-as-investment idea has some problems. Don't buy if you are planning on moving in 5-7 years. Buy in an area where you have some confidence you will be able to find another job if your current job goes away. Take into consideration possible commute-cost inflation greatly in excess of recent inflation. And think long and hard before buying new construction. It costs a premium, and has unknown problems that you'll have to try to get the builder to fix. With previous owners, they have to tell you about all the problems and if they don't, you can go back and sue them. While it may seem counterintuitive, it is sometimes easier to get the money out of a previous owner than it can be to get a builder who well and truly fucked up to make it right.