Monday, March 22, 2010

Why Did We Keep The House?

(I am just now finishing up this post, which I realize has been sitting half-written for months now.)

In my previous post I tried to at least enumerate the costs of renting the house rather than selling it. The rent checks have to cover not only the mortgage but also property tax, maintenance, and return on equity.

(That last one is often overlooked: if you somehow still have positive equity in your house, then if you don't make at least some profit from renting, you're missing the money you would have made by selling and gaining interest on the cash you'd free up.)

And the short answer is: we are probably slightly behind when renting - that is, the cost of property tax, maintenance, mortgage, and a conservative return on equity* are more than the rent minus property management commission. (With the initial costs of getting the house ready, we're definitely behind but that's perhaps to be expected.)

So why did we keep the house? The short answer is: selling it would have been a lot uglier.

Before going on to the specifics, I have to rant about real-estate agent fees. The transaction costs to sell a house are 6%. I can't come up with words to describe how obscene that is. (Even if I could, I'm told that my mother is linking to this blog for the pet pictures, so I'll keep the language tame.) If you had a stock or bond that had a 6% commission to sell it, you'd throw it straight out the window and never look back.

(Wait - mutual funds did have commissions - these were "loaded" mutual funds, and had something like a 5% fee to buy in. They've gone the way of the dinosaur.)

Unfortunately with housing we're still stuck with high transaction costs - any strategy for managing housing investment has to take them into account. I don't think that FSBO represents a great way to save on transaction costs - if we announce FSBO, we probably have to accept buying agents, and even then we're going to get low-balled because the buyer knows we aren't paying that 3% on our side. For transactions to become more affordable, the cost structure needs to decline across the entire industry.

Besides the high basic transaction fee to sell the house, there was another factor: time on market. At the time of the decision, there were almost a dozen short sales in our neighborhood, many where the house was the same layout as ours. The short sale price (yes, many won't sell at all at that price) was perhaps $20k to $40k below "market", which was already really low.

Would we have been able to sell at market by waiting? Well, having let this blog post sit, we now have a historical data point. Our neighbors have been trying to sell their house. Personally I think they have over-priced it (it's easy to call your neighbor's house over-priced, hard to call your own...) but the operative number is over 200 days on market, or over $10,000 in lost rent.

With the great options of fire-selling (at least $20k loss), leaving the house on the market (at least $10k loss) and paying at least $15k in transaction fees, selling didn't pay.

Executive summary:
  • We "make the mortgage".
  • While this feels good, the net return on the house is probably a loss, when you go account for everything.
  • The specific losses to selling in this environment would be worse.
* How do you know how much "return on equity" you should be getting? One simple way to figure this is to ask what you'd get back if you put the money somewhere else. I would suggest a conservative proxy, like: what would you get in an FDIC-insured savings account. It isn't fair to compare return on equity to a highly volatile investment like stocks. Sure you aren't making 6% on your housing equity, but then it is unlikely to plunge by 50% one year.

1 comment:

Anonymous said...

One thing to note about short-sales is they take a long time to transact. So while they can underprice you, you can still compete with them. We looked at several short sales that were very attractive looking when buying our present house, but had to pass up on all of them due to transaction time-- too slow and we end up homeless, too fast and we end up paying two mortgages and requiring a bridge loan.

Btw. our total commission was more like 4% because our buy and sell agents were the same, we negotiated a lower commission, and got some rebate action from the brokerage afterwards (presumably for moving quickly). That's still ridiculous from an investment standpoint, but it's a little less ridiculous.