The NYT reports that Europeans are rushing to buy Manhattan condos, taking advantage of the rise of the euro against the dollar. I guess that losing tens of billions in securities backed by subprime mortgages whetted Europeans appetite for U.S. real estate. The article cites the example of a Belgian couple who just bought a condo for $1.7 million, which will rent for $7,500 a month. The broker who sold the place is quoted as saying, "what else could they do with their money?" Let's see, suppose the condo fees are $1,000 a month, probably a ballpark figure for a high end Manhattan condo. That leaves our couple with $6,500 a month or $78,000 a year in rent on their condo. Now lets, imagine that the condo goes vacant an average of 2 months every four years due to turnover. This reduces average annual net rental income to $74,250. That is a return of 4.4 percent on their investment. Now, let's assume that property taxes are 1.0 percent a year. This gets us down to a real return of 3.4 percent. Now, if condo prices keep pace with inflation, then the 3.4 percent real return would be on a par with what our Belgian investors would get on high-rated corporate debt. Of course, they don't have to deal with the hassle of being landlords to get a 3.4 percent real return on corporate bonds. Now suppose that the condo falls by 10 percent in real terms over 5 years at which point they decide to sell. If we assume 10 percent round trip transactions costs, then we're looking at a negative return of 1-2 percent over this period. Yeah, what else could they do with their money?
--Dean Baker
