patrick.net

My personal metric for affordability has been 200X monthly rent at the high end with 180x being ideal. This would mean a price/rent ratio of 6% minimum and an ideal ratio of 6.67%. That sound about right?

Yes, that sounds about right to me. The first subscriber to my Landlord's Bargain Finder said he would not buy anything above 100x monthly rent, but that's 12% or so, which is pretty damn cheap. I think somewhere in the range of 6% to 7% is at least reasonable, though not very cheap.

Simple conversion formula for multiple of monthly rent (GRM) to percent return:

12/GRM = percent return

samsmom said: I see people asking absurd amounts for small homes like these
I must say, those read like the same ad to me with different lease lengths (discounting for the longer terms). It also suggests the landlord is fishing; can't blame them for trying.
I think people found out about how great the schools are.
This is really the big unknown as schools in weaker districts crumble under the budget crisis. Good areas should see a boost, but if prices get too out of whack, folks may go private.

If a person can live in a home with a decent potential rental option, then moving shouldn't be as much of a problem. Assuming they are sticking with the home for 5-7 years, they should be able to easily rent it out at that point. They could move into a rental or purchase a secondary home. Benefits are numerous, including the capx savings, when a sale does go through, vs selling a pure rental unit. Upgrades might not yield a 100% return, but often they'll give back a 50-70% return, depending on what they are. Essentially you're paying 30-50% to have a nicer living space for 5-7 years.

Life has a lot of unknowns, and it's impossible to plan for them all. A house might be a very illiquid asset, but it's still a pretty decent asset to have. In the event of most financial turmoils, it'll fair better than most other options out there. The loss of a job or medical expense can be brutal on your economic position. If you're a renter and stuck in a lease, you're stuck. If you've got a house, you could either rent the whole thing out, hopefully reducing your monthly bills or pick up a couple of room mates and keep living in it. While some might not like this, it's an emergency plan, and if you're in an emergency, then things have to give. If your plan is to move out of your apartment and move in rent-free with parents or some friend, well you can do the same with a house, you just need to find some tenants. Hopefully this happens after a few years, and rent has appreciated a little. All in all, there are solutions to having an illiquid asset, and there are some good benefits.

Personally, as a renter, I currently rent cheaply, and then pour that saved money into better household decor, after it's purchased, I just save the rest. I figure if I'm going to give up living in a nicer rental place, I can offset that by putting really nice things in my apartment to counter it. So I end up in a situation where I'm saving far above and beyond what my mortgage costs would be. I personally have a lot of time to wait for housing to stabilize, but if my rent was 3/4 of a mortgage payment I would probably consider buying now. Currently, it's probably 1/4 to 1/3 of a mortgage payment, for a house I would consider purchasing. Eventually I'll get bored of renting and switch over. It's nice to see some prices inline with what I would be willing to pay.

Excellent data mining effort. However, this analysis is not entirely correct. The rent in a neighborhood does not vary a LOT between "Low-to-High API" school districts in bay area, but the home prices vary a LOT.
By this analysis the Best places to buy are really "Low to High API" school districts.

Eg: 95130 zip code is interesting. The reason it is 4.1% is because half of the zip code falls in "High API school" and rest in "Low API-school" district. Rent for ~1500 sqft goes for ~ 1800/- to 2000/- across the zip code BUT the homes in the good school district are way expensive than 400K. So, really there is premium people pay for good schools in any market.

I completely agree that the prices are over priced, but I really DOUBT that the rent/buy ratio will go to 6% or 9% for good schools.
For Bay area we should have a slightly different scale:

Good: 9% Low API school district
Good: 6% High API schools

Fair: 6% Low API school district
Fair: 4% High API schools

Bad: 3% Low API schools
Bad: 2% High API schools

School districts don't explain anything, because the same school district is on both the top and the bottom of the ratio. It cancels out.

All things are held equal by the ratio. It's the same location, the same school district. The only question is whether to rent or buy.

Believe it or not, renting does not kill children, nor stunt their growth. In fact, it helps them if they are renting in a better school district than they can afford to buy in.

I bought in Redwood City in the 94062 area code, and got in ROUGHLY at 4.5%-5% ratio, and that was after serial lowballing in the area. The original asking price had a rough ratio of 3.0-3.5%. (I know exactly what the house next door rented for, and how long it took to rent, and it's exact condition/size/etc, since it's owned by a good friend of mine.)

I don't feel I got a good deal at all, and I fully expect house prices to fall further.

It's not a 'good buy' until 10% no matter where it is. A case could be made for it not sucking at around 7.5-8%. Some neighborhoods will almost never be a 'good' buy, and you can argue which neighborhoods will always be 'premium', but it doesn't really matter.

And I define 'good buy' as 'cash flow positive', not as 'the cheapest you'll ever get this house.'

If an area bottoms out at 7% ratio, it's not a good place to buy from a cash flow perspective. If you don't care, then go ahead.

@SF ace

Amazingly well written. Everything rings true. I especially like the point you made on income divergence between a 200K and a 1M purchase price. The 5X salary is still saving, while the 200K salary at 3X is most likely struggling.

I never thought of divergence in terms of tax benefits though, interesting.

Here's another thing to consider when renting... owners that will rent you the house while they still live on the property...

http://sfbay.craigslist.org/sby/apa/1652163564.html

$2,700 per month for this place in Morgan Hill. Comes with live-in owner. lol

Congrats SFBB on your recent home (or condo) purchase. First surfer-x, then Peter P, and now you (who's next?) Hope you are sleeping better at night (the kid, not the house ;-)

pkennedy says

The population of california is set to double in 15-25 years. So while people say there aren’t jobs, there will be jobs to support all those people. People want to live here, immigration is constant, there are new children coming into the work force all the time. There will be more demand over the long run. Whatever job losses we’re having now, will change. Intel might not be able to hire them alll, but the large corporations aren’t the largest hiring sector anyways, it’s the small businesses that are.

The issue is we are not growing "new" companies. This was made painfully clear a few years back by the SJMerc when they published their SV150 back in 2007-08. There is a decline in small companies coming on line and near zero going public to raise funds for expansion, which will fuel job growth. As for the current crop of small companies, many may find them being acquired for their technology IP, rather than workforce.

I suspect that renters are less likely to have kids than are buyers.

This could explain why rents don't go up that much more in better school districts, but prices do. When I did not have kids, and rented, I did not care about school district. Neighborhood, yes, school district, no. Now, I have kids, and bought, so I was willing to pay a school district premium.

It is absolutely true that this means that renting in better school districts is a better deal on a month to month basis than is buying. Long term, don't know. And it's important to remember that some people aren't looking to spend the absolute minimum on housing. Different people value different things, and there's nothing wrong with that.

Looks like growth has gone south.. as was reported months earlier, "Californians" are moving to Texas and the South...

NEW YORK (CNNMoney.com) -- Don't mess with Texas! Cities in the Lone Star State were among the fastest growing places in 2009.

http://realestate.yahoo.com/promo/census-bureau-dallas-posts-biggest-population-gain.html

Dallas-Forth Worth and Houston gained the most new residents of any city -- netting more than 140,000 each -- according to the Census Bureau's annual metropolitan area population estimates released on Tuesday. Meanwhile, music center Austin posted the second highest growth rate among top cities -- 3.1% -- just behind Raleigh, N.C.

thomas.wong1986 says

Looks like growth has gone south.. as was reported months earlier, “Californians” are moving to Texas and the South…

Well Southerners like me have been moving to California for years. We "loaded up the truck and moved to Beverleee!"

And if now it's someone else's turn to get invaded by Clampetts, well PUCKER UP BUTTERCUP and quit your bellyaching. Dadburn Drysdales....

SF ace says

m1ckey6 says

SF ace read the erroneous NYT article about paying down your mortgage and is repeating it as if it is fact.

I love this line too:

“So when you put to two together, high % places are candidates to invest in and low property ratio are candidates to live if it is cheaper to own then to rent, which can happen even in a 4% ratio property.”

It’s a great time to buy or sell RE right SF ace?! Real estate agent trolls need to find somewhere else to practice their BS.

Mickey, I can assure you I am not a realtor or anything related, so no offense taken and I not sure about NYT as I actually read local newspapers instead. I am neither bullish or bearish on housing, but this is a blog of points and counterpoints so I just inject what I see from my perspective, nothing more, nothing less.
Actually, I ran into this site a few years ago “Googling” Marina SF. The big topic of the day then (around 2007) was fortress on Marina SF vs. price must come back down to earth. I was always fascinated to learn why a condo and homes in that area were asking/selling for well over $1,000 a square feet. You figure after the 1989 earthquake, there was no way people will pay that much for landfill?
Reasons why I think there is a divergence of rent/buy ratio and partially MarkSF questions:
1) The tax benefit is uneven. A typical home buyer in Vallejo will rarely see any or very limited income tax benefits while a buyer in Cupertino will be able to utilize the tax benefit to the fullest potential. (0 -35% range) It is fair to say the bigger the price difference, the more valuable it becomes and creates bigger divergence.
2) The benefits of low interest rate is uneven. The effect of lower interest rate is much more impactful to a borrower in a prime zip. Buying cost is a function of interest rates, so if interest rates decrease and borrowing cost decrease, it creates a rent/buy ratio divergence so historical comparision of rent/buy ratio without an accompany interest rate difference is meaningless.
3) The benefit of prop 13 is uneven and is much more valuable to property owners in prime zip thus supply is severely restricted in prime zips. Prop 13 is more valuable today than in 1997 or 1989 as the market basis and taxable base did not diverge in absolute $$ evenly.
4) The impact of this deep recession is uneven. Both in terms of wages and net worth.
5) The impact of foreclosures is uneven. It is hard to find a homeowner underwater in prime, and even less severely underwater.
6) The impact of high housing price is uneven as a high earner/high net worth can absorb the impact of high prices much more easily since other fixed costs are mostly the same. It may take 3X annual income to buy a 200K home, but a person buying a 1M on 5X annual income is still saving a lot more.
7) Personal value is uneven. All my collegues who bought recently does not consider living in shady zip codes and is price insentitive to a certain extent. and most important IMO.
The supply of new single family homes added in the past is uneven. 94127 has not added one single family homes in a few decades even while the prices rose from 100K to 800K while the bay area population expanded from more than 5M in 1980 to closer to 8M currently. Ditto for Berkeley Hills, etc. No new expansion in sight. As the population continues to grow, it is a safe bet that the divergence ratio will continue to diverge as more and more people are added into the mix.

Well put! .. This is exactly what I meant by Bay area home prices being skewed. The "Expensive" neighborhoods generally tend to have good schools and are in high demand.

Areas like Saratoga, Cupertino, Los Altos have very limited new development. So, even if the prices have dropped > 20% in these areas, they will not fall to the 3%-6% range of renting.

So, it really comes down to :

From cash flow point of view Renting in the High API school districts makes sense. However, if someone is WAITING for prices to drop in these areas to 3-6% range I highly doubt that's happening.

I think Patrick did a nice job (and a lot of work) on his table; however, everyone needs to recognize that this is a snapshot of a point in time. Regardless of all the percentages of rent vs. buy, no one really can predict what will happen in the future. There is no guarantee house prices will be higher in "5 to 7" years. That has been the standard claim in recent time(30 yrs) but when you look at home prices over say 100 years(minus bubble years cause that was fake anyways) housing prices have only risen 2% per year.

When you bank on predictions of rising rents and house prices what do you base that on? Is it written into the future that California will really boom in jobs? First rule of investing- past performance doesn't guarantee future results. Same goes for population growth. Aside from illegal immigration, California is losing population. Most people who come here from elsewhere people are appalled by how incredibly expensive to live here unless your making in the six figures. In addition has anyone noticed that jobs are drying up. My particular job is incredibly recessesion resistance but I have been losing some hours of late. Where is this explosion of new jobs going to come from? Construction and development? Seems to be half of what it was at best. The gov gonna have some super duper projects? I think the muni's and the state have pretty much shot their wad. Maybe the fed but they're up to their up to their asses in bailouts and stimuli. Oh, i know, a world war. Opps, we are already in two wars- oh well, why not throw in Iran and north Korea. Should be good. Sure hope we don't run out of money (or will) before we win.

I don't really see any reason to believe that cal is going to have some miracle recovery anytime soon, maybe not for decades. And that albatross of declining real estate prices could hamstring many a plan both for owners and investors if deflation takes hold.

I agree with deanrite. Japan is my favorite example. It's far more crowded and expensive than California, and they're not making any more land there, yet prices fell every year for 15 years, and are still not rising.

True, all kinds of things could happen that makes it a good deal (hyperinflation) or bad deal (earthquake) to buy in California.

Because we can't know the future, I think it's best to go by fundamentals, the way Warren Buffet invests in stocks.

going to correct over next 3 years

My zip code is accurate, rent is 3% (or less) current asking prices. The place sold in 2006 for $979,000. Neighbors just bought a nearly identical place for about $940,000. The HOA is $435. One would have to put down $500,000 at LEAST to come close to my monthly rent.

What are the odds of the government phasing out the MORTGAGE interest deductions for home mortgages... Like they did in some European countries over the course of a 12 year or so period of time until it's totally phased out?

It seems like this would be a practical way for the government to get out of it's national deficit relatively quickly?

rmm221 says

What are the odds of the government phasing out the MORTGAGE interest deductions for home mortgages… Like they did in some European countries over the course of a 12 year or so period of time until it’s totally phased out?
It seems like this would be a practical way for the government to get out of it’s national deficit relatively quickly?

I think unlikely, it's pretty damn popular. But on patrick's front page today is this: http://www.nytimes.com/2010/03/23/business/23views.html

pkowen says

rmm221 says

What are the odds of the government phasing out the MORTGAGE interest deductions for home mortgages… Like they did in some European countries over the course of a 12 year or so period of time until it’s totally phased out?

It seems like this would be a practical way for the government to get out of it’s national deficit relatively quickly?

I think unlikely, it’s pretty damn popular. But on patrick’s front page today is this: http://www.nytimes.com/2010/03/23/business/23views.html

I'm not sure removing the deduction makes sense. Not unless you're going to completely rewrite business tax law too, where interest is no longer a business expense. If the deduction is removed for homeowners, but landlords still get to deduct it, that would be completely absurd.

This actually deserves a whole thread of it's own.

Based on a lease we just signed in December, 94402 in San Mateo looks just about dead on at 3.3%.

People ask us often why we're not buying right now - we could certainly afford to. The questioning often ends though when we take them through this logic about how much you're really paying right now (essentially in rent to the bank and gov't) if you're buying at too high a price.

Another consideration in places like San Mateo or other expensive peninsula cities - you don't get to deduct property tax if you pay AMT. So for higher-end homes where mortgage interest deductions are capped at loan amounts of $1M, if you're also paying AMT, then the effective rent to the bank is really quite high. Say 6% for the jumbo loan, 1.25% in property tax, and maintenance and insurance. Even if you get 1/3 of the interest back, that's still some 5.5-6% in cash out the door. Our rent (for a very nice, large 4.5/3) is the 3.3% ratio. Hard to argue with paying about half-price!

And to echo an earlier comment, you can most certainly rent in the high-scoring school districts at the 3.5% level these days. I saw many examples of that over the past few months. You get the same schools, just for half the price!

Tomrisk says

When the majority think that the R.E. need to or have to go down another 20%, it is a good signal for the bottom was over, and it is time, believe it or not

That's some ace logic right there.

Tomrisk says

When the majority think that the R.E. need to or have to go down another 20%, it is a good signal for the bottom was over, and it is time, believe it or not.

Majority? Three years back majority thought home price always goes up.
Today majority thinks home market crisis is over and it is great time to buy home.

Patrick readers were and are rational but never majority.

Tomrisk says

CrazyMan says

Tomrisk says

When the majority think that the R.E. need to or have to go down another 20%, it is a good signal for the bottom was over, and it is time, believe it or not

That’s some ace logic right there.

Too bad, people never learn. Same logic had happened in 2005.
Crazyman, I bet you are one of the many who do renting now?

I rent my current dwelling but I also own (long paid off).

Your logic still doesn't make sense.

I remember you being such a bear, then you purchased. Funny how people flip flop their opinions in an attempt to justify their decisions.

>>>Same principle of why some people like leasing a car, and most like to buy a new car. People think why should they pay more in order to drive the same fancy car, since others hate to be limited under the contract. Personally, I hate to keep watching my Odometer and worry I will be over the milage limit while driving.

Your car analogy is irrelevant, as the entire premise of this thread is whether home prices are out of whack with rents, as compated to the historical ratio for same (whatever that may be). Car leasing and ownership is likely to be a much more efficient market -- there was no "bubble" in car ownership versus leasing -- so the choice between buying and leasing a car does come down to personal preference.

Does your data include information on how long units have been rented? Renters in a place like the Berkeley Hills (not a big student neighborhood) may tend to stay for long time. With Berkeley's strong rent increase limitations, these rents may be a lot below what the current rental market could fetch, which is the real comparison of interest. Other places may have high turnover and reflect current rental market rates more accurately.

Hmmm, my Oakland Zip Code shows 6.4%. I still think I'll continue to rent...

Tomrisk, you wrote regarding renting versus buying, "you pay about the same $." Not true. That's exactly the point of this thread - you're NOT paying about the same $. By renting at say a 3% equivalent (such as we are) we are paying significantly less than if we bought it, and without any of the capital risk. We're not concerned with price erosion, and we don't have to ensure the property against fire, flood or earthquake. We CAN put nails in the walls (we just need to fill them when we leave). And while I agree that there's downside around concepts like putting on extensions and other major modifications, not everyone needs to do that -- we simply rented a house big enough not to need an extention.

But the real, hard cash we're saving each month is so much at these levels -- we're talking thousands of dollars a month -- that the underlying house could appreciate some 5% a year and we're still neutral on the what it would cost to buy it. In other words, the house (like so many in the better areas) is way over-valued. But the rents are quite economically realistic and a great deal.

We'll probably buy in about another two years or so, but at the current ratios, it just seems like a much better financial decision to rent. Of course to each one's own.

I think the thing we still see as pervasive is this concept (brainwashed by Realtors) that "ownership" is some status level that you are a loser without -- whatever -- our neighbors are thrilled we've moved in, and none of them has turned up their noses because we're renting the house.

Meanwhile, if someone bought that $3.5M house in Hillsborough for $4.2M in 2006, think how'd they feel? Same for the person who bought the stock market at the peak in 2001 of 2007. For some 10 years, the S&P500 has been flat. So if you choose your timeframes, you can always find big winners. And in the housing market, that's been easy. But the question isn't whether I should have bought a house in 1996 before the biggest bubble in history... it's whether the prices are realistic yet post bubble. And the rent equivalents in many of the nicer areas suggest no...

SanMateoRenter says

We CAN put nails in the walls (we just need to fill them when we leave). And while I agree that there’s downside around concepts like putting on extensions and other major modifications, not everyone needs to do that — we simply rented a house big enough not to need an extention.

Personally, I consider it a huge advantage and savings not to be:

1. obligated to do major repairs
2. tempted to do major renovations

I've saved tens of thousands on this alone, for sure. Maybe $100,000.

Patrick

Thanks Patrick - good points. We've rented homes that needed garage door repairs, had flooding problems, and other repair needs. But meanwhile, those owners also wanted to take care of their places, including installing new windows/doors, air conditioning, fencing, etc. All repairs and upgrades at their cost.

Also w/ regard to the whole "putting nails in the walls" and "painting" thing, let's not forget that you need to patch the walls and repaint when you SELL a house too. Just like when you leave a rental, when you try and sell a place you own you have to clean the place up, repaint, patch holes in the walls, etc. So I call BS on this whole "I can't do what I want to my house because I'm renting". When my wife and I are tired of our current colors we repaint.

That's a really good point -- never thought about it that way, but you're right. When I sold a condo many years ago, we spent a lot of money to repaint, replace carpets, fix up other issues, etc. And even if we hadn't, and had given the buyers a credit, money is money - we'd have lost a chunk of cash either way.

I like how Tom changed all his comments to a dot. Just as informative too.

Yeah, I was wondering what happened there...

Maybe he wanted to delete his comments. I used to not have a delete button for comments, or anyway it didn't work for threads the commenter did not create. But you could still edit them down to nothing.

I fixed it. Now anyone can delete their own comments, even if they did not start the thread.

Oh well -- will miss his discourse. Before his untimely departure, he was asking the question why, given what we've discussed, would anyone ever buy a house. My simple answer to that is that beyond the benefits of home ownership which one can certainly appreciate or not, there are pure economic reasons. And at the right price, the risk/reward costs and alternative opportunity costs can align to make it a financially sound decision. Just doesn't look like that's the case when the rent is effectively just 3.x%.

For some people it's a very self-validating and emotional decision. For others (like many here I suspect) it's more a financial prudence decision. And for those folks, this site is a great place for learning how to be informed enough to identify the better financial opportunities/timing to buy in the places we're interested in.

He hasn't gone anywhere. Tom did the same thing all the time on the old board. He's still reading the board, just pouting.

But if you ever reply to one of his posts, make sure your QFT (quote for truth).

I mapped the data to the map. enjoy!

Sunnydavid, where is that map you mentioned?