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Buying / Renting parity is false throughout country
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2012 Mar 13, 2:30am 20,657 views 39 comments
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tatupu,
As for taking out principle - when I've seen others on here analyze rent versus purchase (excepting Bellingham Bob off the top of my head - he does a great job analyzing every detail), they don't factor that in, so I've just been going along with what seems to be the standard.
The point of this whole thing is to show that no matter where you are in the US, buying an expensive home is apparently a terrible idea. Yet, expensive homes are purchased typically (not always) by intelligent, hard-working people. So maybe the premise that rents need to justify purchasing is wrong for expensive homes
The data presented so far doesn't prove the idea that everywhere in the US expensive homes are bad choices. There are plenty of examples of areas like this, and of course, being that we just had a bubble, you are going to find a lot of places that fit that criteria. This correction is taking a long time.
But the abundance of overpriced homes doesn't justify anything. Hard working intelligent people make foolish choices all the time. The .com and housing bubbles are proof of that.
You have to look at the numbers and make a rational decision for yourself. If you feel comfortable paying more to own a home than it costs to rent go for it. Personally I am waiting for the costs to even out. That way if prices don't rise in the short term after I buy I'll at least have the comfort of knowing that l made a sound decision for the long run.
uomo_senza_nome
2012 Mar 13, 3:39am
So maybe the premise that rents need to justify purchasing is wrong for expensive homes.
I think Patrick's calculator works great for most regular house purchases. Expensive house prices => greater risk of decline, given that there's an ongoing secular deleveraging.
A simple thought exercise: does the rent vs. buy logic work for a house right by the beach in La Jolla or a house in North Hollywood?
Not entirely. Rent vs. buy logic will tell us how much a fair value for that place would be. The fact that it is located in a desirable location where a LOT of people would compete to own needs to be factored in. What you could call a "house price premium".
Note: I think it's an insane idea to overpay, but if someone wants to make a risky financial choice, what can anyone do about it?
The data presented so far doesn't prove the idea that everywhere in the US expensive homes are bad choices. There are plenty of examples of areas like this, and of course, being that we just had a bubble, you are going to find a lot of places that fit that criteria. This correction is taking a long time.
So you think Omaha had much of a bubble if any? As I said on a different thread, San Antonio barely had a bubble, but it is cheaper to rent an expensive home than buy there. You can't talk about bubble prices where there was no bubble.
You are waiting for the costs to even out...but what if they don't. You've missed the point. There is no evidence - at least none presented yet, that buying a home should be as cheap as renting one in expensive areas.
Rent vs. buy logic will tell us how much a fair value for that place would be. The fact that it is located in a desirable location where a LOT of people would compete to own needs to be factored in. What you could call a "house price premium".
I agree with this. I think it's fair to say Cupertino, MV, Los Altos and Palo Alto have a house price premium, and for those hoping for prices to fall in line with rents are probably being unrealistic.
uomo_senza_nome
2012 Mar 13, 4:31am
and for those hoping for prices to fall in line with rents are probably being unrealistic.
Probably. The competition is one aspect. Another aspect to consider is this: Saving as such is heavily discouraged through the pernicious monetary and fiscal policies of the US. Everything they do is the complete opposite of encouraging prudent savings.
The Keynesian dogma of consumption being good, good, good has led all policy makers to blindly believe that all they need to support is aggregate demand and everything would be good. When you trash the unit of account used to measure value, obviously the prices measured in the thing you trash is going to look high.
A combination of factors (competition, cheap credit, dogmatic fiscal and monetary policies) are all stacked up against a potential buyer who wants to be very careful not to get into debt.
It is a systemic issue, from a big picture point of view.
The data presented so far doesn't prove the idea that everywhere in the US expensive homes are bad choices. There are plenty of examples of areas like this, and of course, being that we just had a bubble, you are going to find a lot of places that fit that criteria. This correction is taking a long time.
So you think Omaha had much of a bubble if any? As I said on a different thread, San Antonio barely had a bubble, but it is cheaper to rent an expensive home than buy there. You can't talk about bubble prices where there was no bubble.
You are waiting for the costs to even out...but what if they don't. You've missed the point. There is no evidence - at least none presented yet, that buying a home should be as cheap as renting one in expensive areas.
I don't need to wait for anything. As long as renting and investing the money saved over buying is a financially superior decision I will continue to rent.
None of this, in my opinion, has anything to do with future prices anyway, which is probably the underlying premise of the thread. You're arguing that home prices don't have to drop in the future just because they're too expensive now. I'd say that you're right about that. Home prices were too expensive long before the bubble popped. And before the bear market bottoms out they'll likely be "too cheap".
Doing the analysis just helps you make a more informed decision away from the mania of speculation and fear.
RentingForHalfTheCost
2012 Mar 13, 5:33am
I'm not sure you understand the buying vs renting comparison. No one is trying to prove that buying is or should always be cheaper than renting. The point of the comparison is to evaluate the cost of renting vs buying, and then make a wise decision.
What you've basically provided is a list of cities where buying is not a good idea, not proof that people in Monta Vista should all run out and buy houses.
The conclusion from the data provided (admittedly small sample but varying geographics) is that no where in this country is it a good idea to buy an expensive house. To me, that's absurd.
Agreed, and history has enough proof that it will not stay that way. It has not always been more expensive to buy verses rent. There was actually a time where people paid a higher premium to rent because it gave them more freedom from disasters (job loss) and mobility (job change). We are now in an era where most people are happy that the premium is on the other side. The problem now is that there are powerful groups (NAR, Banks, Gov't) that have a vested interest in things staying like they are (buying more expensive than renting). They have exercised everything in their power to protect the buy side. I think history will show that they are fighting a losing battle and we are on the path to eventual parity again. I could be wrong, we could keep draining the savings of the common person to protect the housing market.
In 10 years you might start seeing homeless people that are way up there in age. That will be a sad time for this country. I'd rather see houses drop and a more stable economy prevail that rewards hard work as opposed to sitting on aging building materials getting rich. That is just me, though, and everyone views housing differently.
The analysis is lacking for 3 main reasons:
1) After the mortgage is paid off (or at least 10 years) you have an asset you can sell at current market value, whereas with renting....
2) Rentals are usually in much worse condition than places for sale (at least in my area). They are smaller, run down, in worse locations, etc., and not usually equal to purchase price "value".
3) Rents go up every year or two. Mortgages stay flat unless you refinance.
Why is data necessary to debate your original point? Comparing the cost of renting to buying is just a method of measuring whether or not it is cheaper to buy or rent, and way of quantifying how much cheaper or more expensive it would be. Even if you decide you're willing to pay a premium for the privilege doing the analysis will at least let you know how much that premium is.
The calculated risk blog has a chart showing average price to rent ratios going back to 1983. You can see here http://www.calculatedriskblog.com/2012/02/real-house-prices-and-price-to-rent.html that prices are falling back into line with ratios last seen in the 90s.
tatupu70
2012 Mar 13, 6:18am
Fine, I'll accept that no one can/will find a city today where an expensive house is cheaper to buy than to rent.
That's why I pointed out the flaws in your simple analysis. If you take out a mortgage, inflation is very much relevent. Principle HAS to be taken out of the equation since it is not really an outflow. On expensive houses, the MID is likely higher than the cost of maintenance.
I think you'll find the rent vs. buy to be much different if you do a more thourough analysis.
RentingForHalfTheCost
2012 Mar 13, 6:19am
Here is some insightful data about renting verses buying you should read.
http://economics21.org/commentary/renting-v-buying-new-evidence-emerges-informs-housing-policy
Quote from the above article
"A new academic article in Real Estate Economics turns this conventional wisdom on its head. Using data from 1979 to 2009, the authors demonstrate that renting was the superior investment strategy for most of the past 30 years."
Also, if you want to scare yourself about the future of California housing check this nice nugget of data out. This is not going to end well in my opinion.
Why is data necessary to debate your original point? Comparing the cost of renting to buying is just a method of measuring whether or not it is cheaper to buy or rent, and way of quantifying how much cheaper or more expensive it would be. Even if you decide you're willing to pay a premium for the privilege doing the analysis will at least let you know how much that premium is.
Because it is one of Patrick's pillars (actually the 2nd one, presumably they are listed by importance) as to why now is not a good time to buy. If the cost to buy is never cheaper than rent for expensive houses, then it is not a valid point as to why NOW is not a good time to buy.
The calculated risk blog has a chart showing average price to rent ratios going back to 1983. You can see here http://www.calculatedriskblog.com/2012/02/real-house-prices-and-price-to-rent.html that prices are falling back into line with ratios last seen in the 90s.
I don't see a separation of expensive houses in there.
RentingForHalfTheCost
2012 Mar 13, 6:32am
One quote from the "academic article" I referenced above that really sums up the analysis. I don't think we are going to get 3.62% annual appreciation over the next 8 years, hence I rent. Pretty simple. Especially in the BA. I also understand that I could be wrong here, but am willing to be wrong. Being wrong from me would just mean I take my hard earned cash and move to somewhere else in the country and buy with no mortgage. Still works for me.
Quote:
"This implies that the average potential homebuyer in the U.S. should require appreciation of more than 3.62% annually during the next eight years in order to justify buying rather than renting a home. If the potential homebuyer believes that real estate appreciation in the U.S. is likely to be less than 3.62% annually during that period, renting is preferable to buying."
BTW, if you look at the tables in the back, where they break out the city, San Francisco requires an annual appreciation of 7.4% in order for the buying to be on par with renting. 7.4%! Maybe -7.4% will be achievable. ;)
If the cost to buy is never cheaper than rent for expensive houses, then it is not a valid point as to why NOW is not a good time to buy.
Fair enough. It is often used to explain now w/o being compared to any historical reference points.
So here's a house:
http://www.redfin.com/CA/San-Diego/4120-Avati-Dr-92117/home/6255741
Mortgage calculator says it should be about $2k per month (assuming 20% down).
And here's a similar sized house in the same neighborhood listed for $2900 /month.
http://sandiego.craigslist.org/csd/apa/2899112149.html
There's an expensive area where, depending on how you factor in the costs of appreciation/depreciation it could be cheaper to buy.
That's why I pointed out the flaws in your simple analysis. If you take out a mortgage, inflation is very much relevent. Principle HAS to be taken out of the equation since it is not really an outflow. On expensive houses, the MID is likely higher than the cost of maintenance.
I think you'll find the rent vs. buy to be much different if you do a more thourough analysis.
Your suggestions are to
I still don't see how inflation is relevant to a snapshot in time. Yes, if you compare over the life of the loan, but I didn't do that.
I agree principal should be discounted, but if everyone is going to do it wrong on this site, I'm going to be consistent.
FWIW, the first year would be about $1k/mo principal and steadily rising to $1.5k/mo in eight years and so on. So if you take out principal, you get closer to even initially and eventually surpass it.
I agree with you, tatupu, that in the long term other factors should be considered and then using Patrick's calculator probably is sufficient for comparison purposes. The point of this thread was to rebut patrick's argument that because rents are cheaper right now, it is better to rent than to buy. Maybe I missed his point, and he was actually doing a full analysis. The numbers I've seen quoted when most people make their point on this site is: today I pay $x/mo in rent and the place I could buy is $x+y/mo ; therefore, I'm better off. They don't do the full analysis.
Fair enough. It is often used to explain now w/o being compared to any historical reference points.
So here's a house:
http://www.redfin.com/CA/San-Diego/4120-Avati-Dr-92117/home/6255741
Mortgage calculator says it should be about $2k per month.
And here's a similar sized house in the same neighborhood listed for $2900 /month.
http://sandiego.craigslist.org/csd/apa/2899112149.html
There's an expensive area where, depending on how you factor in the costs of appreciation/depreciation it could be cheaper to buy.
I appreciate you finding some data. It does show that some higher priced houses can rent for the same or more.
Now it depends on what "expensive" is considered. I used Cupertino and $1M as an example because that is where people in the BA think prices are going to collapse to $600k. In the BA, Cupertino, PA, MV and Los Altos are all above $1M for the most part. By comparison, $500k is not expensive. I don't mean that in a condescending way; I just mean for the initial comparison, $1M was the mark to be used, not $500k.
I appreciate you finding some data. It does show that some higher priced houses can rent for the same or more.
I tried to find another house, one that my wife and I were actually looking at, but it's off the market again (it has gone in and out of pending the past few months). It was priced at about 450,000, and comparable rents were about $2000. We did a more thorough comparison of that house to the cost of renting (including using patrick's calculator) and found that it was very close. One key we found was that without the current interest rates it would be a completely different story, and Bernanke seems content on leaving them near zero until 2014 so we're holding out a little bit longer.
RentingForHalfTheCost
2012 Mar 13, 7:00am
Here is an opposing view from a SVP at NAR. I went right to the belly of the beast.
http://economistsoutlook.blogs.realtor.org/2011/06/08/rent-or-buy/
If you read carefully you will see the same arguments that many realtors use repeatedly. Compare this to the team of unbiased people who did some real analysis on the subject bringing in years of data and looking at all the parameters.
http://www.fma.org/NY/Papers/Lessons_from_30_years_of_Buy_vs_Rent_Decisions.pdf
You decide for yourself the integrity and biasing of each report.
Expensive homes were cheaper than rent in the past. Really? When? Where's the proof? The only point that I've seen that says prices should be lower than rent is Patrick's #2 reason why now is not a good time to buy. Again, it's just an opinion without any data to back it up.
Agreed. Unfortunately, there does not seem to be any actual proof that ive seen. To the extent there is proof of the relationship (here or in other research articles) they are always too broad to answer the speciffic question about expensive houses being historically as cheap as renting.
Unfortunately, I am going to do a bit of the same thing here in that while I do recall seeing and learning each of the following years ago, I dont remember where that was and am not inclined to find it now. So you should take what I say with a grain of salt, but I do recall.
1. A research paper indicating that there are exceptions to the "rental parity" rule, in that in certain areas of detroit, the reverse is true in that it is historically cheaper to buy than rent! I think they said the same was found historically in indianapolis as well. Now, if that is the case in that the "prices must equal rents" rule can be violated to the downside then yes, it is logical to assume that there are also some areas where there is a premium attached to ownership such that prices will never equal renting.
2. I recall seeing an article where Robert Shiller said that some areas that are particularly attractive to people, prices are indeed higher than rental parity, but that "over the long run", rental parity will reassert itself when (and I shit you not about this) new cities are built! Of course the problem is the "long run" that Shiller is talking about year is decades or even human lifetimes, and if thats the case, I was not going to wait decades or potentially human lifetimes to buy.
Sorry I dont have any further proof of items 1 and 2 above. However I do recall seeing them such that I was no longer convinced that rental parity will always re-assert itself in all situations.
Dont get me wrong, I think there are still very good reasons to wait. However, based on what I have seen, waiting around until all areas and all homes are at or near "rental parity" is just not one of them.
Dont get me wrong, I think there are still very good reasons to wait. However, based on what I have seen, waiting around until all areas and all homes are at or near "rental parity" is just not one of them.
I think you're looking at the metric from the wrong perspective. The object is not to wait for rental parity. It's to use the rent to price ratio make the right decision now, to rent or to buy, based on which is financially more beneficial.
Or, if you wish, to decide that the extra cost of buying is a "premium" you are willing to pay for.
Whoa. What's really missing here is comparing the median prices. A million dollar home in Austin is on the extreme upper end there. You can buy your pick of houses in Austin for 200k or less. Meanwhile in the Bay Area 500k is more like what you pay for a POS.
rootvg
2012 Mar 14, 9:05am
that no where in this country is it a good idea to buy an expensive house. To me, that's absurd.
I don't think any reasonable person on patrick.net would disagree with you there.
The bloated housing prices are supported by cheap credit and holding the mortgage market in a sort of a stasis condition for the benefit of the big banks. If at least a fraction of those bloated values were marked to market, we would see another significant decline.
But they aren't, and they won't be at least in the Bay Area and certain desirable cities around DC. Arlington, Great Falls, Falls Church, Vienna and Mclean are a few that immediately come to mind. And guess what? Summers there are absolutely unbearable. Summers here are hot but dry.
If you're not in technology and you need to find an affordable city with opportunity that's good for young families, check out Indianapolis, Columbus or Pittsburgh. Leave your progressive politics behind. They don't want to hear it.
I think you're looking at the metric from the wrong perspective. The object is not to wait for rental parity. It's to use the rent to price ratio make the right decision now, to rent or to buy, based on which is financially more beneficial.
Or, if you wish, to decide that the extra cost of buying is a "premium" you are willing to pay for.
Perhaps, but it also depends upon one's goals.
If I may, without mentioning specifics, too often I see the following line of reasoning on these blogs...
1. Rents must equal purchase prices.
2. Currently in area XYZ where I am looking its 40% more expensive to buy than it is to rent.
3. Therefore, prices in areas XYZ will fall 40%.
4. Since I dont want to end up -40% underwater, I will wait until sanity is restored.
This is a little simplistic but you get the idea. In this case, the person's ultimate goal is to buy a house without having to worry that they will soon be -40% underwater. For that person, the question as to whether any premium or not exits, and (how big of a premium is justified) will have a large impact upon whether the decide to wait or to buy sooner.
If the answer is, "no premium over rental parity is justified", then that person will wait as long as it takes to achieve their goal of not being underwater.
However, if the answer is "some expensive areas do historically have a premium" then (and only then) your question as to what premium they are willing to pay for, comes into play.
Whoa. What's really missing here is comparing the median prices. A million dollar home in Austin is on the extreme upper end there. You can buy your pick of houses in Austin for 200k or less. Meanwhile in the Bay Area 500k is more like what you pay for a POS.
Not relevant. The point of the thread is comparing rents with purchase costs for expensive homes (similar to Cupertino prices). It doesn't matter if it's a 2bd condo in Manhattan or a 6 bd mansion in Kansas.
freak80
2012 Mar 14, 11:19pm
If you're not in technology and you need to find an affordable city with opportunity that's good for young families, check out Indianapolis, Columbus or Pittsburgh. Leave your progressive politics behind. They don't want to hear it.
Well put.
freak80
2012 Mar 14, 11:21pm
No offense, but do you have any reason to think it will ever exist in the area you plan on buying? Your short post with no justification proves a secondary point that some people are hoping for something that may not exist and may never have.
Hey tina, you could try looking in the "Real Estate Tools" section. The fact that you obviously haven't says a lot about your motives...
No offense, but do you have any reason to think it will ever exist in the area you plan on buying? Your short post with no justification proves a secondary point that some people are hoping for something that may not exist and may never have.
The point is that the relationship of that financial decision to your income determines whether you're committing financial suicide. Anyone who's dead set on some day buying a house under the current system can certainly go right ahead and do it. I see that decision, especially when there isn't rent parity, as the end of a person's financial freedom. They no longer have money of their own.
Expensive homes were cheaper than rent in the past. Really? When? Where's the proof? The only point that I've seen that says prices should be lower than rent is Patrick's #2 reason why now is not a good time to buy. Again, it's just an opinion without any data to back it up.
As luck would have it, we now have SOME proof that this is false.
If you look at the comments, Irvine Renter notes
"When I did a rental parity study of Corona Del Mar, at the bottom of the last recession from 1993 to 1999, it was still 84% above rental parity" and later that "It has been trading above rental parity consistently since 1988 which is as far back as my records go"
While not dispositive, I would say that 24 years of trading above rental parity is fairly good proof that waiting for rental parity to appear before you buy in some areas is a really really bad idea.
For the parity to exist on buy/rent from year 1 would indeed be an insanely good deal for the buyer. That's why it will never happen in bay area. You gotta figure that in the future, the buyer will have the opportunity to sell the pad and get some of their PITI back - even if you assume the most dire scenario where the pad price will stay the same in nominal terms (historically it has went up with inflation), then the buyer will get the P part back. Also, renters, at least those who live in apartment complexes are very likely to suffer from inflation "rent increases" year in and year out, whereas the interest part of the PITI goes down every month causing an inverse relationship to the renter. Then, you have to factor in the tax break on the IT part of the equation. Given these variables, it is unlikely that in the affluent bay area, that the parity will exist from day 1. However, it is entirely possible when you compare apples to apples, that it will exist by year 5 or so. And I am not even talking about prepaying the mortgage will will expedite the process.
Here's my list of cities where buying is more expensive than renting. The data is from redfin and craigslist. Assumptions - 20% down, 4.625% 30 year fixed rate. I tried to use comparable houses based on sq ft, beds, etc.
1) Cupertino (in particular Monta Vista) - recent 3/2 (1500 sq ft) houses have sold for $1M - $1.2M
http://www.redfin.com/CA/Cupertino/1057-November-Dr-95014/home/785645
So PITI = $4100 + $1000 + $100 = $5200/mo
Rents range from $3000/mo - $3700/mo.
2) Omaha, NE - 4 to 6 bd/ 4 to 5 ba houses (3000 sq ft - 6000 sq ft) houses are for sale at $1M - $1.1M
PITI = $5200/mo (I think it is actually higher because of higher property taxes, but not sure)
Rents = $4000
3) Austin, TX - 4/4 (3500 sq ft) houses have sold for $1M-$1.1M
http://www.redfin.com/TX/Austin/3407-Northwood-Cir-78703/home/31241430
PITI = $4100 + $2500 (based on 3% tax rate) + $100 = $6700/mo
Rents seem to be about $4500.
4) Scottsdale, AZ - 4/3 (4000-5000 sq ft) houses have sold for $1M-$1.1M
http://www.redfin.com/AZ/Scottsdale/9798-E-Piedra-Dr-85255/home/28406838
PITI again would be around $5200/mo.
Rents range from $3000/mo - $4000/mo. Some houses listed on craigslist are higher, but they seem to be fully furnished vacation homes, so not valid comparisons.
5) Alexandria, near DC - 4/3 (2500-3500 sq ft) houses have sold for $1M
http://www.redfin.com/VA/Alexandria/2715-King-St-22302/home/11860282
PITI - guessing around $5200/mo
Rents - $3000-$4000 (not much to choose from)
So from the SW to the East coast and two in the middle of the country, it would be cheaper to rent than to buy a home comparably priced to a Cupertino home. So where is the assumption that rents have to justify purchase prices in expensive places like Cupertino, Los Altos, Palo Alto coming from?
If any of the numbers above are wrong, feel free to correct. This was a quick and dirty search. If you have any additional info from other cities, please add, so that people have a clear picture and aren't falsely waiting (er, I mean hoping) for that $1.1M house in Monta Vista to come down to $600k.