Wednesday, December 06, 2006

Don't Buy if it is Cheaper to Rent - A simple rule

This is a very simple economic rule:

Do not buy a property if it is less expensive to rent that property.

Many of you can relate to the experiences of recent years when house prices were just going insane. If you bought a home prior to 2003, the price increases made you feel like you made the investment of your life. Some of you might have even made the mistake of dipping into that equity through a line of home equity credit. I hope that you didn't.

I remember colleagues at that Fat 4 Accounting Firm were I worked in 2004 that would show up in the office in tears because they were outbid on a house that they didn't even have the opportunity to see before making an offer on it. I thought to myself, why would I want to buy a home in a market where I was expected to offer more than the asking price without even having the chance to see the place? Is that the way a market is supposed to work? The simple answer is, no.

People speak of "sellers' markets" and "buyers' markets", but you know what, there is only one type of market, and that is the one you choose to participate in. Why would you even think about participating in a market where you as a buyer are not the one being pursued? Do you go to a car dealer and put a bid on a car without being allowed to even sit in it? Every market is a "buyers' market". If it isn't, it’s not a market you want to deal in!

There is a great book written by Charles Mackey titled, "Extraordinary Popular Delusion and the Madness of the Crowd". It explains episodes not unsimilar to those we experienced recently in "hot" markets such as California, Florida, the Northeast, and in the Washington DC suburbs. Read the chapter on tulip mania in the Netherlands and you may say, "those people were mad and invested fortunes in worthless tulips not house", but you would be missing the point. Is losing $20,000 on a tulip bulb after the mania passes different than taking a 10% hit on that Northern Virginia studio for which you paid $200,000 when you could have rented the place for $1,000 a month?

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