What is the reasonable rate of return on a house?
Story writing contest for a Cupertino house [Burbed.com]
Elsie Says:
May 10th, 2008 at 12:21 pmLooked this house up on Zillow
Last time sold: 11/08/1999: $500,000
Scary thought: Apparently also listed in the zip code and Cupertino at the “median” price
• 95014 ZIP code $1,175,500
• Cupertino $1,175,500So question: did they overpay in 1999 or is it reasonable to get 8% per year (over 9 years compounded interest) in increase in their “investment”?
What is a reasonable rate of return on a house?
Good question… what is the reasonable rate of return on a house? I’m guessing 10% for a Real Bay Area House
May 11th, 2008 at 7:55 am
Aren’t house returns for the BA hovering around -$50k a year, to -$100k a year, depending on house location, size, condition, etc?
Nowhere else will you have bragging rights like this!
May 11th, 2008 at 8:43 am
People who treat houses like an investment that need to deliver outsized ROI are part of the problem.
May 11th, 2008 at 8:49 am
10% is over the top. At 7%, the value doubles every seven years. During boom cycles, houses may appreciate faster than 7%, but those cycles are typically followed by a correction or a flat patch that drives the long term yield well below 7%.
May 11th, 2008 at 9:00 am
Rule of 72. 7% doubles every 10 years. 10% doubles every 7 year.
Historically houses have returned just a couple points after inflation. 2002-2005 was about significantly above the expected rate of return. Note actually house prices can increase more than that if people are buying more expensive(bigger houses) or doing work that improves the long term value of the house (add rooms,…)
May 11th, 2008 at 9:52 am
Roughly speaking:
Housing = inflation + population growth
Diversified stock index = GDP growth = inflation + population growth + productivity growth
May 11th, 2008 at 10:26 am
eichler, thanks for the correction.
May 11th, 2008 at 1:12 pm
The above method of estimating the return on a house by only looking at the increase in price is flawed. The returns on a house is
Rental yield - expenses + inflation + growth in price
A $1.175 million Cupertino house rents for about $3000 or a rental yield of about 3%. The expenses for a house you own outright are about 2.0% which include property taxes ane maintenance. With inflation at around 3%, if you assume prices rise at 7% per year, the total return is 3% - 2% + 3% + 7% = 11%
But can prices rise 7% every year? In the 1960s I heard most families had just one working parent and homes were typically 3 times income. Assuming a home in Cupertino was priced at $75,000 in 1968, it would now be worth $1.15 million at 7% growth for 40 years. A family earning one-third the house price in 1968 (about $25,000) if their income grew at 4% per year would be earning about $120,000 close to Cupertino median income in 2008.
The house price to income ratio has grown from 3 times income to about 10 times income. No wonder the typical mortgage has changed from 30 year fixed to an interest only or negative amortization mortgage. In the last couple of years more than half of the mortgages were either interest only or negative amortization.
Any bets on whether this is sustainable over the next 40 years?
May 11th, 2008 at 2:00 pm
@Gavin- There is almost no question in my mind that those rates are not sustainable. Markets have a tendency to revert to the mean over time. The appreciation over the last few years is way above average. Substantial amounts of inflation and/or growth in income will be needed in order to maintain today’s prices in the bay area.
May 11th, 2008 at 10:13 pm
My point is not that “the appreciation over the last few years is way above average” but the appreciation over the last 35 years is very unlikely to be repeated. In the 1970s much of Silicon valley was orange groves that got converted. The orchards got converted into the high-tech capital of the world. Now that low-value agricultural land has been converted into high-value office buildings and houses you cannot expect the same returns going forward.
May 11th, 2008 at 11:25 pm
Now that low-value agricultural land has been converted into high-value office buildings and houses you cannot expect the same returns going forward.
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Gavin,
Very good point. But it can expect similar return provided it continues to keep having job and economic growth (atleast in same rate, if not more). But I simply don’t see that kind of growth in bay area.
May 11th, 2008 at 11:28 pm
If we assume 20% down orginiallly we are talking a gain from 100K to 500K+ which is marvellous. Assumes that they can sill for 1M+. In any case that kind of a gain takes care or paying more than renting for the last 10 years easily.
The question as was pointed out was is it sustainable.
May 11th, 2008 at 11:28 pm
I meant sell it for 1M+ above.
May 12th, 2008 at 12:02 pm
Gavin,
a minor and somewhat picky point ( I only correct for others that are not familiar with the Santa Clara Valley, aka ” Silicon Valley”) but the Santa Clara Valley was never a big orange growing region. The main fruit crops were cherries, apricots, prunes,and I’m sure there are some others I am forgetting. Where I grew up in Sunnyvale there were still a few cherry orchards in the late 60’s, early 70’s. People had and still have individual orange trees but I don’t believe there was ever an actual commercial orange grove in the Santa Clara Valley ( Someone please correct me if I am wrong).
May 12th, 2008 at 12:12 pm
Gavin,
I think you under-estimate the power of innovation and the level of entrepreneurship in the area. I believe just the opposite. I think the best years of tech are still ahead of us.
May 13th, 2008 at 4:15 pm
There have always been certain enclaves that hold value better than the surrounding “average” homes. But even those places do experience price declines at some point, and all signs point to it. Imagine the Bay Area as land getting flooded. As the waters rise, more and more of it is underwater. Some say that the mountain peaks will “never” be flooded, but they have no understanding or control over market forces. It can easily be measured that almost every market now is a buyer’s market, as can be confirmed on the Altos Research site. Choose a city and see how badly each is impacted — even Los Altos. Their Market Action Index defines 30 as the crossover point and anything below that as a buyers’ market. A few “Real Bay Area” ratings:
Cupertino: 23.59
Hillsborough: 20.34
Los Altos: 26.24
Los Altos Hills: 15.08
Los Gatos: 15.55
Menlo Park: 22.26
Palo Alto: 28.69
Portola Valley: 19.34
Saratoga: 21.44
Sunnyvale: 20.52
Woodside: 14.70
Some observations here — the very high end is having the most trouble on this index (Portola Valley, Woodside, Hillsborough etc). You would expect a mixed-income place like Sunnyvale to have a slowdown, but there is no working-class portion of Los Altos Hills.
And just for grins:
East Palo Alto: 14.24
Fremont: 19.62
Milpitas: 14.59
Newark: 17.54
Stockton: 18.57
Now, the crap towns above have steady price declines and the “better” towns above are merely plateauing, but this is just a matter of time.
Norcalboomer, you are correct about The Valley of Heart’s Delight (Silicon Valley’s original nickname). We’ve gone from fruits and nuts (well, not that many nuts) to chips and disks. Oranges are not commericially viable here because they are vulnerable to frosts and freezes, and it can go below freezing here. In winter of 1990/91 we had a hard freeze with temps at 20 overnight, very unusual weather but a lot of citrus trees were killed by it. Fruit is killed outright by temps under 30, young trees by temps under 25, and more mature trees by sustained temps under 25.