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It’s a well known fact that as property value rises the yield on rental income decreases. A $180k townhouse can rent for $1600/mo but a $1.8m McMansion isn’t g

by zaroth 8y ago

It’s a well known fact that as property value rises the yield on rental income decreases. A $180k townhouse can rent for $1600/mo but a $1.8m McMansion isn’t going to rent for $16,000/mo. The economics of this has to do with marginal utility mainly and nothing to do with exploitation. There’s also the calculation of fixed rental costs which derive a larger portion of the monthly payment the lower the payment gets. If management costs are $100 per month that’s 10% of a $1,000/mo rent. Finally, there are costs like interviewing, turnover, payment risk, eviction risk, legal costs, damage exceeding security deposit risk, and trying to factor this in can dwarf the underlying carrying cost of the property. Some of these are likely to be inversely correlated with property value.

mhuffman 8y ago
This exactly! Also upkeep. Replacing a cheap shingle roof vs a metal or Spanish tile roof are night and day in costs. Plumbing is cheaper in a cheap small house with simple layout vs. Sprawling multi-level house. Size of grounds (and expected level care) to maintain are different. It goes on and on, but the gist is that the total net on a cheap house (ie. houses in cheap areas) is going to be more for the same level of investment. I don't even see how this is unexpected or controversial!
- privacypoller 8y ago
  this is similar to our experience in commercial properties as well, which removes the emotionally charged aspects of "taking advantage of poor people" - landscaping, interior finishings, painting, etc are all large costs in nice retail properties, and non existent in functional light industrial or trades-oriented buildings, yet rents are generally higher for the later.
- zaroth 8y ago
  TFA also makes another good point but somehow makes it sound evil; In low-cost cities, landlord profit rates rise steeply alongside neighborhood poverty. But in expensive cities, the reverse is true. In expensive cities, landlords make money through appreciation and gentrification (which is bad enough for the poor). In lower-cost, more economically hard-hit cities, they make it on the backs of the poor. If the home value is flat or even falling, then of course the rent will have to be higher to provide the necessary return on capital to bother owning the rental property in the first place! It’s not like capital is required to be deployed to rental stock in certain proportions. There is whole world of potential investments, and based on their risk and return will have a whole world of dollars competing for them. Rental units that appreciate fast enough are just held vacant in some markets, so much so that Vancouver had to abundantly tax it to try to stop it. Rental property appreciation is an absolutely key variable in the profitability calculation. In many markets it totally dominates the equation over the actual rental income figure.
  - mhuffman 8y ago
    There is a sense it this new socio-political climate that we live in, that people should not invest to actually make money, but only use what money they have to make other people's lives easier or better. I am not saying that this is a terrible goal, but it is wildly unrealistic for people that are not billionaires. Sadly, however, this ends up in accusations of exploitation, both because of these (imo unreasonable) thoughts, but also because there is a wild lack of economic literacy.
    - pmiller2 8y ago
      > wildly unrealistic for people that are not billionaires. Bullshit. Someone with an invested net worth of $10M exclusive of home value can generate an income of $300k using a conservative safe withdrawal rate of 3%. Anyone making $300k as an individual with a paid off home has more than enough money to be comfortable anywhere in the country, with no real need to invest further. $10M net worth is a large, but not absurd amount, but even if my numbers were somehow off by an order of magnitude, we’re far from billionaire territory.
      - mhuffman 8y ago
        > wildly unrealistic for people that are not billionaires. >> Bullshit. Ok, "wildly unrealistic for people that are not double-digit millionaires!". My intent was that it was a small amount of people in that group.
        pmiller2 8y ago
        True, but you can cut those numbers by ~50% and still be very comfortable in most, if not all places in the US. According to https://dqydj.com/net-worth-percentile-calculator-united-states/ https://dqydj.com/net-worth-percentile-calculator-united-sta... there are over 3 million households with a net worth over $4.5M. Relatively speaking, that is a small number, but, collectively, the good those people could do if they came together would be immense. Of course, this will never happen.
  - 8y ago
- tfehring 8y ago
  Taking GP’s example of a $180k townhouse vs. a $1.8M McMansion, will these costs really be significantly more than an order of magnitude more expensive for the latter, and therefore significantly higher as a percentage of property value? My intuition is that the opposite would be true, i.e., that the difference would typically be less than a factor of 10.
tgb 8y ago
I'm confused. If the marginal utility of a mcmansion is not ten times that of the town house, then why does the mcmansion sell for ten times the price? Are you saying it's being used as a store or value or investment or something?
- deleted 8y ago
  [deleted]
- zaroth 8y ago
  Is social status a factor in marginal utility? If it is, is there a better term to reflect the value of comfortable shelter and diminishing returns to increasing square footage per occupant? That sort of thing.
dls2016 8y ago
> The economics of this has to do with marginal utility mainly and nothing to do with exploitation. That's vacuously true when you simply ignore the existence of exploitative landlords (aka slum lords) who fail to maintain their units because they know that vulnerable populations lack the resources to fight back.
- mgleason_3 8y ago
  So, it’s the existence of “slum lords” that causes the higher profit margins? Interesting. So, if you buy a home in an area with lots of slum lords, the you make more? Seems like there would be a lot of money pouring into slum lord areas. Seems like that would drive housing prices up...and either rents would have to go up or profits would fall.
  - candiodari 8y ago
    There isn't of course, because of what's required: 1) you must destroy people on occasion, make them homeless 2) crime, violence and cleaning up
cmauniada 8y ago
This is a really good point, as someone who has seen first hand exactly how fast cheaper houses rent out vs more expensive ones, this point is very succinct.
JamesBarney 8y ago
I think a lot of this is also landlords make up a smaller percentage of the market as you go up in price and when you get to a 1.8 million dollar home the rent will never justify costs to a landlord. Two facts cause this. The first is it's always a better deal to live in a property than rent it out.(100% occupancy, no expenses to find tenants, no evictions, etc). Plus there are non-financial reasons people prefer to own. This means all things being equal owner occupiers almost always outbid landlords. The second is high income individuals are more likely to be able to buy a home than low income individuals. Basically what happens is in high income neighborhoods, owner occupiers(or developers) bid up the properties until it doesn't make financial sense for landlords to own them anymore. The returns just don't justify it, but the house might still be worth it for owner occupier because they get a better return and want to own a house or lock in neighborhood.
- Retric 8y ago
  Buying and selling a home has huge transaction fees which destroy this argument. Worse, economy of scale still applies with apartment complexes paying less for the same services than condo owners.
  - JamesBarney 8y ago
    Transactions fees don't destroy the economics of supply and demand.
    - Retric 8y ago
      “100% occupancy, no expenses to find tenants“ You very much need to find an owner or tenant when you move out. Further, someone needed to pay to find you when you move in. Move every 3-5 years and home ownership is really expensive.
      - JamesBarney 8y ago
        > You very much need to find an owner or tenant when you move out. Further, someone needed to pay to find you when you move in But this is true whether you buy to occupy or rent. > Move every 3-5 years and home ownership is really expensive. I'm not sure that landlords own homes for significantly longer than buyers.
skookumchuck 8y ago
It's the same as Henry Ford making a fortune selling Model Ts when car manufacturers for the rich went bust left and right.
nickpsecurity 8y ago
Almost all the low-income rentals, esp trailers, down here in Mid-South have predatory or apathetic landlords. The rent is already high for what they offer, there's surprise fee's/fines for petty stuff, people dont get their deposit back for stuff that was already there, renters cant afford lawsuits, and we're told how bad evictions are on our credit report. Almost every bad operator I knew from over a decade ago is still in business with bigger lots than before. So, this is a factor.

by zaroth 8y ago

mhuffman 8y ago

This exactly! Also upkeep. Replacing a cheap shingle roof vs a metal or Spanish tile roof are night and day in costs. Plumbing is cheaper in a cheap small house with simple layout vs. Sprawling multi-level house. Size of grounds (and expected level care) to maintain are different. It goes on and on, but the gist is that the total net on a cheap house (ie. houses in cheap areas) is going to be more for the same level of investment. I don't even see how this is unexpected or controversial!

privacypoller 8y ago
this is similar to our experience in commercial properties as well, which removes the emotionally charged aspects of "taking advantage of poor people" - landscaping, interior finishings, painting, etc are all large costs in nice retail properties, and non existent in functional light industrial or trades-oriented buildings, yet rents are generally higher for the later.
zaroth 8y ago
TFA also makes another good point but somehow makes it sound evil; In low-cost cities, landlord profit rates rise steeply alongside neighborhood poverty. But in expensive cities, the reverse is true. In expensive cities, landlords make money through appreciation and gentrification (which is bad enough for the poor). In lower-cost, more economically hard-hit cities, they make it on the backs of the poor. If the home value is flat or even falling, then of course the rent will have to be higher to provide the necessary return on capital to bother owning the rental property in the first place! It’s not like capital is required to be deployed to rental stock in certain proportions. There is whole world of potential investments, and based on their risk and return will have a whole world of dollars competing for them. Rental units that appreciate fast enough are just held vacant in some markets, so much so that Vancouver had to abundantly tax it to try to stop it. Rental property appreciation is an absolutely key variable in the profitability calculation. In many markets it totally dominates the equation over the actual rental income figure.
- mhuffman 8y ago
  There is a sense it this new socio-political climate that we live in, that people should not invest to actually make money, but only use what money they have to make other people's lives easier or better. I am not saying that this is a terrible goal, but it is wildly unrealistic for people that are not billionaires. Sadly, however, this ends up in accusations of exploitation, both because of these (imo unreasonable) thoughts, but also because there is a wild lack of economic literacy.
  - pmiller2 8y ago
    > wildly unrealistic for people that are not billionaires. Bullshit. Someone with an invested net worth of $10M exclusive of home value can generate an income of $300k using a conservative safe withdrawal rate of 3%. Anyone making $300k as an individual with a paid off home has more than enough money to be comfortable anywhere in the country, with no real need to invest further. $10M net worth is a large, but not absurd amount, but even if my numbers were somehow off by an order of magnitude, we’re far from billionaire territory.
    - mhuffman 8y ago
      > wildly unrealistic for people that are not billionaires. >> Bullshit. Ok, "wildly unrealistic for people that are not double-digit millionaires!". My intent was that it was a small amount of people in that group.
      - pmiller2 8y ago
        True, but you can cut those numbers by ~50% and still be very comfortable in most, if not all places in the US. According to https://dqydj.com/net-worth-percentile-calculator-united-states/ https://dqydj.com/net-worth-percentile-calculator-united-sta... there are over 3 million households with a net worth over $4.5M. Relatively speaking, that is a small number, but, collectively, the good those people could do if they came together would be immense. Of course, this will never happen.
- 8y ago
tfehring 8y ago
Taking GP’s example of a $180k townhouse vs. a $1.8M McMansion, will these costs really be significantly more than an order of magnitude more expensive for the latter, and therefore significantly higher as a percentage of property value? My intuition is that the opposite would be true, i.e., that the difference would typically be less than a factor of 10.

tgb 8y ago

I'm confused. If the marginal utility of a mcmansion is not ten times that of the town house, then why does the mcmansion sell for ten times the price? Are you saying it's being used as a store or value or investment or something?

deleted 8y ago
[deleted]
zaroth 8y ago
Is social status a factor in marginal utility? If it is, is there a better term to reflect the value of comfortable shelter and diminishing returns to increasing square footage per occupant? That sort of thing.

dls2016 8y ago

> The economics of this has to do with marginal utility mainly and nothing to do with exploitation. That's vacuously true when you simply ignore the existence of exploitative landlords (aka slum lords) who fail to maintain their units because they know that vulnerable populations lack the resources to fight back.

mgleason_3 8y ago
So, it’s the existence of “slum lords” that causes the higher profit margins? Interesting. So, if you buy a home in an area with lots of slum lords, the you make more? Seems like there would be a lot of money pouring into slum lord areas. Seems like that would drive housing prices up...and either rents would have to go up or profits would fall.
- candiodari 8y ago
  There isn't of course, because of what's required: 1) you must destroy people on occasion, make them homeless 2) crime, violence and cleaning up

cmauniada 8y ago

This is a really good point, as someone who has seen first hand exactly how fast cheaper houses rent out vs more expensive ones, this point is very succinct.

JamesBarney 8y ago

I think a lot of this is also landlords make up a smaller percentage of the market as you go up in price and when you get to a 1.8 million dollar home the rent will never justify costs to a landlord. Two facts cause this. The first is it's always a better deal to live in a property than rent it out.(100% occupancy, no expenses to find tenants, no evictions, etc). Plus there are non-financial reasons people prefer to own. This means all things being equal owner occupiers almost always outbid landlords. The second is high income individuals are more likely to be able to buy a home than low income individuals. Basically what happens is in high income neighborhoods, owner occupiers(or developers) bid up the properties until it doesn't make financial sense for landlords to own them anymore. The returns just don't justify it, but the house might still be worth it for owner occupier because they get a better return and want to own a house or lock in neighborhood.

Retric 8y ago
Buying and selling a home has huge transaction fees which destroy this argument. Worse, economy of scale still applies with apartment complexes paying less for the same services than condo owners.
- JamesBarney 8y ago
  Transactions fees don't destroy the economics of supply and demand.
  - Retric 8y ago
    “100% occupancy, no expenses to find tenants“ You very much need to find an owner or tenant when you move out. Further, someone needed to pay to find you when you move in. Move every 3-5 years and home ownership is really expensive.
    - JamesBarney 8y ago
      > You very much need to find an owner or tenant when you move out. Further, someone needed to pay to find you when you move in But this is true whether you buy to occupy or rent. > Move every 3-5 years and home ownership is really expensive. I'm not sure that landlords own homes for significantly longer than buyers.

skookumchuck 8y ago

It's the same as Henry Ford making a fortune selling Model Ts when car manufacturers for the rich went bust left and right.

nickpsecurity 8y ago

Almost all the low-income rentals, esp trailers, down here in Mid-South have predatory or apathetic landlords. The rent is already high for what they offer, there's surprise fee's/fines for petty stuff, people dont get their deposit back for stuff that was already there, renters cant afford lawsuits, and we're told how bad evictions are on our credit report. Almost every bad operator I knew from over a decade ago is still in business with bigger lots than before. So, this is a factor.