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Higher Price to Rent Ratios May Be Justified in Certain Neighborhoods
2011 Jul 15, 1:39am 6,911 views 28 comments
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Patrick
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2011 Jul 15, 2:12am
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.
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Certain categories of stocks have higher price to earnings ratios than others (technology P/Es are higher than utilities) and certain neighborhoods should have higher price to rent (P/R) ratios than others. The growth of rents is different in some neighborhoods than others.
Let's break down neighborhoods into the following categories:
1. Urban (like NYC or San Francisco, not crappy urban)
2. Prime suburbs (like Palo Alto in CA and Bronxville/Rye in NY)
3. Regular suburbs (Fremont in CA and Mount Kisco in NY)
4. Exburbs
I think the useful economic life of housing is different in these areas. 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).
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.
Prime suburbs will probably do just fine. Over my lifetime, I think it will be business as usual in these areas.
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.
Now we need Patrick to tell us what the P/R ratio should be in all these neighborhoods :)
#housing