Bailout

Rent-vs-buy calculation of the day, Nouriel Roubini edition

By Felix Salmon

Back in May, Nouriel Roubini held his book party at DBGB. He obviously likes the location, since in September he paid $5.5 million for the triplex penthouse upstairs. (EV Grieve has the photos of what is now the most expensive apartment ever sold in the East Village.)

It’s an interesting move, given what Roubini said back in 2006:

I?m bearish on the city. I live in Tribeca in a nice loft, and in four years, it?s increased 150 percent in value. That price appreciation doesn?t make sense. Now there are maybe twenty developments under construction in my neighborhood that are going to come to market in the next year. There?s going to be a huge glut. I see demand falling and supply going sharply up. So you?re going to see some pretty nasty price action…

It?s not as if there?s infinite wealth. There are thousands of new luxury units coming on the market, and the question is, who will buy them? If people start losing jobs, who can afford to pay 2, 3, 4, 5 million dollars?

Before it was sold, the apartment was offered for rent at $25,000 a month, which means we can plug the various numbers into the great NYT rent-vs-buy calculator. Roubini put down $2.5 million and took out a $3 million mortgage; I’m assuming he got a mortgage rate of 4.5%, that he can get a long-term return of 4% on his investments, that long-term inflation is 2%, and that his marginal tax rate is 40%.

Let’s say that Roubini is neither bullish nor bearish, and reckons that neither the price of the apartment nor the cost to rent it will change, going forwards. In that case, he seems to have made a bad decision:

(Incidentally, this assumes that common charges are $1,240 a month, which seems cheap to me; I reckon that in reality they’re likely to rise over time.)

If home prices have the “nasty fall” that Roubini predicted in 2006, things get much worse, of course. Let’s say they go down by 2% a year on average. In that case, even if the rent goes up by 1% a year, it’s still better to rent than to buy.

Basically, in order to make buying this place make economic sense over a 5-10 year time horizon, you need to be pretty bullish over the long term:

Of course, I’m sure that non-economic considerations came into play here. But if Roubini thought that the very idea of $5 million apartments is ludicrous and unsustainable, and that the value of this place is likely to fall by a seven-figure sum over the medium term, I can’t imagine that he would have made the decision to pay $5.5 million for it.

Full post as published by Macroprudential on December 17, 2010 (boomark / email).