patrick.net

I don't see why the price/rent ratio should be different anywhere.

Everything cancels out because it's on the top and the bottom of that fraction when you're considering whether to rent one house or buy an identical one next door:

* same size and quality house
* same location
* same school district
* same transportation options

Sure, some neighborhoods are more valuable than others, but they are more valuable by exactly the same amount for both renters and owners, right?

In actual fact, I know that the E/P ratios (percent return) are much higher in poor neighborhoods (gross rent = 10% of purchase price per year, 7% net after expenses) because poor people cannot get loans or save up a downpayment, and therefore are forced to rent. This means landlords make money in poor neighborhoods, but not in rich ones, where the gross returns are only 3% per year (0% after expenses). Ironically, the poorer people rent but should buy, and the richer people buy but should rent.

A side effect of that is that rentals are hard to find in nice neighborhoods, because landlords actually run the numbers and refuse to overpay. But people buying on emotion overpay all the time, putting themselves in a dangerous state.

I don't see why the price/rent ratio should be different anywhere.

Everything cancels out because it's on the top and the bottom of that fraction when you're considering whether to rent one house or buy an identical one next door:

* same size and quality house
* same location
* same school district
* same transportation options

What if the neighborhood was in a spillway or other potential destructive location? Could be expensive to rent but cheap to buy.

Let me rephrase my point: Do you think rents will increase at the same rate in the future in the exburbs and a good urban area?

If you expect rents to increase at the same rate, then price to rent ratios should be the same in the exburbs and the urban area.

If rents are expected to grow fasted in an urban area, then the price to rent should be higher in the urban area.

The price to rent ratio is a static measure - it does not account for the expected growth in rents.

Do you think the price to earnings ratio should be the same for all stocks?

Prime, I agree completely with your thesis about the increasing importance of urban areas and have made similar arguments on this board for a long time: a civilization based on high-density urban areas where everyone lives, surrounded by productive farmland from which food is imported in bulk to the cities, is the sustainable and egalitarian society in which humans have always lived and is what we should be preparing for and striving for.

Krugman is entirely correct about the elevator: it is one of the greatest contributions to quality of life in human history. It enables buildings to extend to many times the heights previously possible and thus makes ultra-high-density cities livable as square mileage becomes less important than cubic mileage. Every human being is able to use them, and they take up so little space that old buildings can easily be retrofitted to have them.

James Howard Kunstler has called America's car-dependent post-WWII culture "the biggest malinvestment in history", and he's right. I think the US will continue to go downhill until the exurbs finally die and a new culture of safe city living comes back.

Ironically, the poorer people rent but should buy, and the richer people buy but should rent.

great stuff Patrick, these are amazing times.

Ironically, the poorer people rent but should buy, and the richer people buy but should rent.

This is an interesting point. I partially agree. Poor people who are in a good city, but not the best neighborhood (say the outskirts of Harlem or the Tenderloin) should probably buy. These neighborhoods should improve as more people move to the city.

I don't know if poor people in the exburbs should buy (like Tracy, Stockton). I think prices will continue crashing in these neighborhoods as gas continues to march upwards.

"We are running out of oil (geologists say we have already used 50% of total world supply), and the exburbs are only viable when gas stays below a certain price. Some say we will all be telecommuting and driving cars that get 200 mpg in a few years, but I am skeptical. I think rents and prices will eventually go to zero in the exburbs (so the P/R should be low now)."

We aren't "running out of oil" as this implies a few things.

1) that somehow we are using oil up the same way universally
and
2) that there cannot be any replacements for the usage of oil

Todays trucks get as much mpg as cars did in the mid 70s. Plastics are generally made from oils and are being recycled or replaced with other forms.

Scarcity means that prices go up as anyone that remembers the 70's or 2005-current times can tell you. But that means that cars that get higher mpg have a higher value (remember the prius backlog?)

I think the end of cheap and easy oil is over. Having said that tar sands will start up and coal gasification so it's not like it is going way it just will take longer.

"Regular suburb areas that are walking distance to public transportation should hold up ok/only suffer moderately, but the areas that resemble the exburbs (i.e. you need to drive to get anywhere) will probably suffer."

That can be argued to a point but not all urban areas even have public transport. Some of the trains and buses are extremely packed these days.

"I think urban areas will flourish over the coming years. Face to face interaction is important and I don't think technology will overcome this. I agree with Paul Krugman that the best mass transportation invention ever is the elevator. I think people will move from the exburbs/regular suburbs to cities, so they can afford the commute. The denominator of the urban P/R should rise, so a high ratio at the moment may be justified."

Face to face? Not really. Most of the people I know that have decent jobs actually have to travel to do that face to face stuff.
Technology has overcome a number of jobs. Instead of a bank clerk it is a ATM, instead of a cashier it is self checkout, instead of a telephone operator it is tts and voice recognition (tell me services) even a mcdonalds can be outsourced
http://www.cbsnews.com/stories/2005/03/11/national/main679730.shtml
Let's not also forget elance.com you can solicit for anything for programming, design, websites, writing etc.

Krugman doesn't really get it. He slams ebooks and then later he started selling them!
http://www.nytimes.com/2008/06/06/opinion/06krugman.html

I can agree with you that cities will become more attractive but for other reasons... the whole "white flight" is over. The reason for leaving either have changed or frankly they don't care about. Younger people want more things to do and suburbia generally doesn't have them. Yes there can be bars but there aren't as much in terms of sports, theater, museums, music concerts, schools etc. Houses require much more maintenance than an apartment. Cars already have a cost (registration, emissions, keeping it up) without factoring in oil

Nomograph says

I don't see why the price/rent ratio should be different anywhere.

Except that they are different, and always have been.

That's right. It is different here. Lotsa people covet to live in the Cool and Hip Communities Along the Left Coast. Hipsters from the midwest and other parts of the USA, Alternative Lifestyle folks who are not welcome in communites dominated with the intolerance of a 10-ounce trout, wealthy Asians.
All these kinda folks covet living here enough that they bid up the rents and house prices against each other for what they view as the perk or privilege of living here. For a No-Nonsense person from a No-Nonsense part of the Heartland of the USA of course it does not make sense and is not rational, but this is not the Heartland. Not rocket science, but it is different here.

Sybrib says

it is different here

But once you're here, the tolerance level is exactly the same here whether you rent or own, right?

Is there more tolerance in California for say, gay owners than for gay renters? No, it is exactly the same. In fact, no one knows if you rent or own unless you tell them.

Compare an owner to a renter living in an identical house next door. All the conditions are identical for those two people.

So you get a rent/price ratio for the left coast, and you get a rent/price ratio for the midwest. Why should those two ratios be any different from each other?

Prices and rents may be higher in CA than in the midwest, but the ratio should be constant.

Price
Rent
Income

These have historical correlations. Only through special types of leveraging does price become permanently detached. The "this area is special" and "everybody wants to live close to the city" should be reflected through household income increases, not one's imagination. If the demand for home prices goes up in an area, thus reflecting the increased demand and "buyability", then so too will rents.

Nomograph says

I don't see why the price/rent ratio should be different anywhere.

Except that they are different, and always have been.

When observation doesn't support theory, it's time to retool the theory; that's the basis of the scientific method. Clinging to a theory despite mounting evidence to the contrary because that's how it "should be" is the basis of ideology.

Another meaningless lecture from Nomo.

klarek says

Another meaningless lecture from Nomo.

Yes. You are right, of course. Forget historical data. Forget facts. If Klarek says so, then any other opinion is meaningless.

tatupu70 says

If Klarek says so, then any other opinion is meaningless.

He didn't have an opinion. That was the point.

klarek says

tatupu70 says

If Klarek says so, then any other opinion is meaningless.

He didn't have an opinion. That was the point.

I think he was saying that we should try to reconcile the difference between the theory (price to rent ratios should be the same everywhere) and the facts (price to rent ratios are very different across neighborhoods). This seems like a reasonable comment.

Nomograph says

A better question is "why ARE those two ratios different from each other."

I think it is a mix of emotion buying that Patrick referred to AND expected growth in rents. Google has a price to earnings ratio of 22, whereas Microsoft has a P/E of 11 because the market expects Google's earnings to grow faster than Microsoft's.

Similarly, I think the market has good reason to believe San Francisco rents will increase faster than Tracy rents, so a higher price to rent ratio is justified in SF. I am not sure what the equilibrium ratio in SF is through.

You can't expect to get $200 ppsf in high income neighborhood. You can certain get that in low-mid income neighborhood. So, of course higher price to tent ratio does exist.. Higher demand, lower rental supply equal higher price to rent ratio for those who want to live there. It just cost more. What's the mystery?

I like the rent/price ratio because that comes out to a simple percentage that you can easily compare to other investment opportunities. Price/rent ratio is too confusing.

So the rent/price ratio for Menlo Park, CA where I live is about 3%. Meaning that the gross annual rent is about 3% of the purchase price for the exact same house.

In the far East Bay (Antioch, CA and Pittsburgh, CA) the rent/price ratio is about 10%.

Why is that? I think the answer is mostly that people in those poorer neighborhoods have a harder time borrowing money to buy a house now that the bubble has crashed.

So the poorer people should buy because prices are now low compared to rent for the same thing, but they can't.

And the richer people shold not buy because prices are still too high compared to rent for the same thing, but they don't care. They prefer to own even if it's a financially dumb decision.

Landlords, however, know the score exactly, and they do buy in the poor neighborhoods now, and they stay away from the rich neighborhoods. And that's one reason it's difficult to find a rental in a rich neighborhood -- the landlord would lose money on it. That 3% is only enough to pay maintenance and property tax and not much else.

In my own case, the landlord has owned a long time and pays almost zero property tax because of Prop 13, so they're happy to rent out a house and skim off money as private profit that should have gone to the state as property tax.

I shouldn't complain though, because I benefit from that as well. I get to live in a rich neighborhood at less than half the cost of owning the exact same thing in the same neighborhood. At public expense, because of Prop 13.

PRIME says

Do you think the price to earnings ratio should be the same for all stocks?

No, but stock earnings vary a lot more than rents. Rents are fairly consistent and predictable from incomes.

Or to phrase it another way, yes, if stock earnings were consistent and predictable.

OK, if you could tell that San Francisco rents were going to skyrocket, then you would be justified in paying a very large premium for a San Francisco house to capture that future very high rent. I just don't think rents move nearly fast enough to justify current prices.

I don't see why the price/rent ratio should be different anywhere.

I don't see why they should be the same everywhere.

There are two populations (in the statistical sense) living sometimes in side by side communities. Since they are separate and distinct populations, it's not always right to presume the same behavior from them, because they are different.

I have been looking for a place to buy in the Bay Area. No matter how hard I look, I haven't found much houses or condo that has a good rent and buy ratio. I have been told if 15 * yearly rent should buy. Well, there isn't any house and condo to justify it. I don't this ratio works in the Bay Area.

looking says

I have been told if 15 * yearly rent should buy

Demand is willing but the supply is weak.

In my own case, the landlord has owned a long time and pays almost zero property tax because of Prop 13, so they're happy to rent out a house and skim off money as private profit that should have gone to the state as property tax.

I shouldn't complain though, because I benefit from that as well. I get to live in a rich neighborhood at less than half the cost of owning the exact same thing in the same neighborhood. At public expense, because of Prop 13.

Interesting way of looking at the situation!

PRIME says

Do you think the price to earnings ratio should be the same for all stocks?

No, but stock earnings vary a lot more than rents. Rents are fairly consistent and predictable from incomes.

Or to phrase it another way, yes, if stock earnings were consistent and predictable.

This is a fair point.

One thing to consider is the MID. More expensive houses will yield more savings and therefore have a different rent/price ratio parity.

My calculator does take the Mortgage Interest Deduction into account.

My calculator does take the Mortgage Interest Deduction into account.

right, but a simple rent ratio doesn't.

We have something inspired by prop 13 in mass..it's prop 2 1/2.

Property taxes can go up but by only 2.5%. If that isn't enough then they have an override if voters approve it (it is rare..but not as rare as it used to be)

But if they can't raise the taxes then can still raise the assessment. The 1990's saw valuations skyrocket as tax rates didn't go up..but assessments did. It is odd because technically people might actually be paying the same amount had taxes been allowed to go up...

The paradox is some believe that the market is good because after all assessment rates went up...but that's not really the case. It is almost as if a car insurance company called a '99 Corolla a antique to justify a massive premium.

I've also heard in some states that the state government gives significant amounts to their capitals for their budgets. This intern could create less of a need for property taxes which could lead to more development.