By Marc Courtenay
The buy-versus-rent question is particularly relevant right now as we see home prices continuing to decline and interest rates on new mortgages also going down to the lowest levels in 60 years.
Back in April of 2010 The New York Times did an impressive job of explaining the ratio that helps define whether it is economically more sensible for residents to buy or rent their housing. Part of the purpose of the article was to help those looking for housing to decide. http://www.nytimes.com/interactive/2010/04/20/business/20100420-rent-ratios-table.html
The Times analysis is based on comparing the costs of buying and renting a similar home, using data from Moody’s Economy.com, a research firm, and from real estate agents. This kind of comparison can never tell someone for sure what the best financial move will be. However, it does show whether a buyer will need a big jump in future prices to cover all the costs of owning — including the down payment, closing costs, property taxes, mortgage interest, repairs and co-op fees.
A simple way to do the comparison is to look at something called the rent ratio: the purchase price of a house divided by the annual cost of renting a similar one. The number 20 provides a useful rule of thumb. When you do the math, you discover that a ratio above 20 means you should at least consider renting, especially if you may move again in the next five years or so. When the ratio is well below 20, the case for buying becomes a lot stronger.
In many large metropolitan areas, including New York, Los Angeles, Chicago, Houston, Dallas, Atlanta and South Florida, the average ratio is now 16 or lower. It was more than 25 in several of these places at the peak of the bubble, about five years ago. Recently The Times asked Mark Zandi the chief economist at Moody’s Analytics about the chances of yet another housing crash happening and his current analysis of “The Rent Ratio”. His answers are revealing:
Q. I’m struck by how much higher the rent ratio still is in many places, relative to its average from 1990 to 2010. It’s about 18 in Washington (relative to a 1990-2010 average of 13), about 17 in Boston (relative to 15) and 15 across all metropolitan areas (relative to 11). Is there any reason to think the ratio should remain higher in the future than it was in the not-too-distant past? Or should we expect the ratio to continue falling in coming years, either through further house-price declines or through rent increases?
Mr. Zandi: I expect the house-price-to-rent ratio to continue falling at least through the remainder of this year and next. National house prices are set to decline by 5 percent this year, and apartment rents are on track to rise by about 5 percent. I do expect home prices to stabilize in 2012, but rents will continue to rise strongly. Supporting the strong rent growth is declining apartment vacancy rates. Apartment demand is healthy given the better job market and accelerating household formation, particularly among younger households that generally rent, and the ongoing foreclosure crisis which is forcing families from home ownership into renting. Apartment construction is also especially low by historical standards. If this script roughly holds, the house-price-to-rent ratio will be back close to its long-run average in most areas of the country by 2013.
Q. When we were talking earlier, you mentioned that a straight comparison of rents and home prices argues for renting in most places — but that once you consider other factors, the issue becomes a closer call. Can you explain what you meant?
Mr. Zandi: A literal interpretation of the current house-price-to-rent ratio argues that it is still better for most households to rent rather than buy. This suggests that a prospective home buyer might want to wait until house prices fall even more before buying, but there are several important things to consider. Most of the coming house price declines will be for distressed properties — foreclosures and short sales. And timing the precise bottom of house prices is an intrepid affair, and may not the best strategy if the homeowner plans to live in their home for more than a couple of years, as most homeowners do. It is also important to keep in mind that mortgage rates are extraordinarily low, with the rate on a 30-year fixed rate mortgage currently well below 5 percent. Rates could go lower, but it is unlikely. As the economy continues to gain traction and the Federal Reserve ends its zero interest rate policy, mortgage rates will move higher. Indeed, in a well-functioning economy fixed mortgage rates will be closer to 6 percent.
The entire interview can be found at http://economix.blogs.nytimes.com/2011/05/11/is-another-housing-crash-coming/?scp=6&sq=rent%20ratio&st=Search The still high price-to-rent ratio means that home buyers shouldn’t be in a rush to buy a home, but owning is quickly looking more attractive, and it won’t be long before owning is once again more financially attractive than renting.