Markets
Should You Buy or Rent?
Renting may be smarter if home prices in your area will fall further.
By Pat Mertz Esswein, Associate Editor
From Kiplinger's Personal Finance magazine, April 2010
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If you're a renter, you may be champing at the bit to buy a house after watching prices fall for four years. Is it time to jump? It may well be, especially if you want to capture the home buyer's tax credit (you'll need to have a contract by April 30 and close by June 30). But before you leap, you need to go beyond calculating the impact on your monthly budget and figure out how much home-price froth is left in your local housing market.
Encouraging signs. A key number to consider when switching from renter to homeowner is the price-rent ratio. This figure compares a city's median home price with its median annual rent. At the housing market's peak in 2005, the national median home price had inflated to nearly 21 times the median annual rent. By the third quarter of 2009, however, the ratio had deflated to 15, returning to the historical norm, according to Hessam Nadji, managing director of Marcus & Millichap, a commercial real estate brokerage company in Encino, Cal.
If the price-rent ratio where you're looking to buy is 18 or higher, your market may still be in the bubble zone, with a greater probability that home prices will fall after you buy. That could put you underwater -- meaning your home would be worth less than what you owe on the mortgage. If the ratio has fallen below 15, there's less chance that home prices will sink.
The table on Rent or Buy below shows the ten cities in which home prices are least likely to drop further, as well as those most likely to fall further, based on price-rent ratios. We also show the gap between median monthly apartment rents and median monthly mortgage payments. Five years ago, the difference between monthly mortgage payments and rent was $745 nationally; by the end of 2009, it was just $181.
To get a rough estimate of your local price-rent ratio, divide the average list price of several homes that meet your criteria by the average annual rent of several rental units with the same number of bedrooms and comparable amenities.
Weighing the decision. A year ago, the price-rent ratio in Phoenix was 14 -- down from almost 19 a year earlier. Home prices had fallen by half, and mortgage rates were at historic lows. Financial planner Brendan McNamar decided it was finally time for him to buy. He had rented since moving to the city in 2006, just after the housing bubble peaked, and was sitting on a nice nest egg from a home he had sold in 2004.
McNamar shopped for a long time, made offers on several houses and eventually bought a ten-year-old, four-bedroom, three-bathroom short sale listed for $219,000. (In a short sale, the sellers get permission from the lender to sell for less than the mortgage amount.) The house had sold for $355,000 in 2007. McNamar offered the full price, which the bank eventually accepted after 90 days. He put down 20% and took out a 30-year mortgage with a low fixed rate of 5.25%. He pays $1,176 a month (including taxes and insurance), which is more than twice his former monthly rent of $550. But because he hadn't owned a home in the past three years, he was able to snag the $8,000 first-time home buyer's tax credit.
From an investment perspective, McNamar wanted a house that would allow him to break even or earn a profit if he sold in three years. But given that prices have fallen even further in Phoenix since last spring -- the price-rent ratio is a rough guide, not an infallible one -- he reckons that his break-even point now may be four years away. But it's not a big financial setback to him because he has no plans to move.
Good deals for renters. Renting can be a smart strategy while waiting for this choppy housing market to settle down. Consider Jeremy Portnoff and his wife, Heather, of Edison, N.J. By mid 2009, the median home price in Edison had fallen a healthy 19%, to $317,000, from the market's peak in mid 2006.
The Portnoffs had their heart set on a home with three or four bedrooms to accommodate the family they hope to have, plus an office for Jeremy. The house they could afford was a starter home, probably a small townhouse -- which, on an after-tax basis, they figured would cost them about the same as renting.
But the Portnoffs also figured that if they sold it in three years, real estate commissions would consume any gains they could reasonably expect. Plus, Jeremy believed that the price of their ideal home in that area would continue to decline.
So they took a pass on buying and got a great deal on renting a two-bedroom townhome -- $1,550 a month, $300 less than when they looked at the same development three years before. The couple prudently plan to continue to pay down debt and save for a larger down payment on their next home.
In some markets, rental prices have dropped as supply has increased. By the end of 2009, the vacancy rate nationally had grown to 8.2%, a 30-year high, according to Nadji, of Marcus & Millichap. Meanwhile, rents had fallen 5.8% from the year before.
Markets with the highest vacancy rates include Jacksonville, Fla. (forecast at 14% in 2010), Atlanta, Houston, Las Vegas, Orlando, Phoenix, Tampa and Tucson. Renters in such markets can afford to shop around and negotiate hard. A building's leasing manager may be willing to lower the rent to attract or keep your business.
Nadji expects the vacancy rate nationally to tighten up a bit (to 7.8%) by year-end and start a rapid recovery beginning in 2011, with very strong rent growth between 2011 and 2015. Demographics (five million people will enter the peak renter age range of 20 to 34 over the next decade) and plummeting construction starts in 2009 and 2010 drive his forecast.
Not all cities have an excess of rental units, though. In some large cities, such as New York, downtown Chicago, San Francisco, Los Angeles and Washington, D.C., vacancy rates have remained tight -- and home prices have remained stubbornly high.
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Reader Comments (4)
Posted by: Mike in Dallas at 03/21/2010 03:02:18 PM
I believe this type of article contributes to the problem of overspending. First, the down payment is not shown above over 30 years .. $30000 would be $83/month. Taxes and insurance for houses are higher than apts. Maintenance is higher .. and years later much higher. All of these things are negligible with Apartments. And .. the house is not worth anything unless someone will buy it. In fact, as we know now it can be worth less than what you owe. A house is the worst investment you can make unless you plan to buy it for a lifetime. I have owned 5 houses in my life .. but 15 years ago I started renting and now I am retired and on easy street. All the money that I would have spent on houses is sitting in the bank, Take my advice and rent an apt -but do not rent a house.
Posted by: JD at 03/22/2010 12:41:25 PM
People say that renting is "throwing money away" but so is buying - you either pay mortgage interest or lose the investment opportunity that the money you put into the house has if you kept it out and invested it. Housing isn't free no matter how you slice it, so you need to analyze all the numbers. That said, right now, buying is almost certainly the answer. Interest rates are ridiculously low, and prices aren't to high either. This idea of waiting for prices to fall further is ludicrous. If the price falls by 10% but interest rates rise by 1%, it will cost more to buy than it does now. Realistically, interest rates will increase by much more than 1% in coming years. No realistic price decrease can overcome that. Now is the best time to buy you'll ever see again.
Posted by: Homeowners of Texas at 03/22/2010 06:09:17 PM
EMPLOYMENT FLEXIBILITY. Renting gives people mobility and access to job opportunities they might not have if tied down as a homeowner. This benefit applies to young people and anyone out of work in this recession. IS THE AMERICAN DREAM A NIGHTMARE? For decades, the U.S. government has subsidized homeownership, resulting in overinvestment in residential real estate and a major cause of the current crisis. Yet Washington had been adding even more housing subsidies, thus deepening the federal commitment to the old strategy and making it harder to move to a new one. 1. Mortgage Interest Tax Deductions 2. Artificially Low Interest Rates and Adjustable Rate Mortgages. 3. Tax Credits for first time home buyers is promoted as free money, and Congress extended the program to repeat buyers. This tax credit is like a drug, and the housing industry is addicted. Extending the credit just worsened the problem. 4. Down Payment Assistance. FHA rules make the down payment issue worse by allowing volume builders to give buyers the required 3% down payment through third-party non-profit corporations such as Nehemiah Corporation in California. Builders give money to Nehemiah, who then gifts the funds to the buyer for a small fee paid by the builder. 5. Federal Mortgage Insurance. Banks normally want 20% down but gladly lend when the government insures loans with just 3% down. FHA, VA, Freddie Mac and Fannie Mae now guarantee some 80% of all new mortgages, thus putting the burden of risky loans onto taxpayers. 6. Low Down Payments. The USDA now even has a zero-down home loan program. It was a homebuilder proposal primarily aimed at generating wealth for builders, realtors, mortgage lenders, and Wall Street. They knew, or should have known, that zero-down loans would put borrowers at risk and taxpayers on the hook. Buyers with little or no skin in the game are more likely to default on loans and go into foreclosure when inflated home values fall below what is owed, or when property taxes or adjustable interest rates rise, or when employment or medical problems arise.
Posted by: Brett at 08/25/2010 08:31:54 AM
Renters cannot control whether a lease will be renewed or not, potentially forcing them to move on short notice. Renters cannot make desired improvements without permission. Renters pay increased rent as the years go on, a fixed-rate buyer pays the same year after year. Renters receive no equity or tax breaks for their payments. Every analysis of rent vs. buy depends on the situation... the person involved, the interest rate available (currently 3.75% for a 15-year loan), the amount of time one will stay in a house, the area, the condition of the house, whether or not one is responsible financially, etc. But for the long-term buyer, the savvy buyer, the handyman, or the control-freak--buying is a no-brainer. You can't look at personal home ownership as JUST an investment, which a lot of people here are doing. There are memories and emotions tied up in a personal property. I also have three rentals, all cash-flowing and getting paid-for by tenants, which I why I love the comments here... the way you guys think puts money in my pockets! I will be paying my same 3.75% rate ten years from now, but I will probably be charging $2000 a month in rent instead of the $1400 I charge now.