Homes: Rent or Buy?
The affordability index has been bouncing around in the 180 to 200 range since the beginning of this year – the highest reading since the index was first used in 1971.
Palm Coast, FL – June 9, 2011 – The cliché says that there has never been a better time to buy. The hard data in the housing affordability index confirms that. The affordability index, which takes into account median income, median home price, and mortgage rates, has been bouncing around in the 180 to 200 range since the beginning of this year – the highest reading since the index was first used in 1971.
Yet, you still encounter consumers hesitant about taking advantage of possibly the greatest home buying opportunity of a lifetime. Should they buy now or not?
Let’s consider the situation in which a family earns $60,000, which is about the national average. They are renting at $1000 per month. They are considering buying a home that requires them to take out a mortgage of $170,000, which would be fairly close to the current national median home price.
At the current rate of 4.8 percent on a 30-year fixed rate mortgage, the monthly mortgage payment would be …(drum roll) … $891 per month. That’s not all. A measurable portion of the monthly mortgage payment is actually goes towards principal reduction on the loan balance. For example, in the first year about $215 of the mortgage is for the principal payment, which in essence is a forced-disciplined savings imposed on the home buyer. The remainder $676 ($891 minus $215) is the pure interest payment to the bank. So the $676 monthly mortgage interest payment looks a lot sweeter than the $1000 in rent that was being shoveled out the door. With each passing year, the principal portion gets larger while the interest portion declines because of a steadily falling loan balance.
That’s still not all. A fixed rate mortgage means the monthly payment is fixed and will not rise for the term of the mortgage. In this example, a person theoretically could be paying $891 in mortgage in the year 2041. What would be the cost of living at that time? Food price? Gasoline price? Also rent?
If rent was to rise by 3 percent a year, starting with the base $1000, the monthly rent will be $1344 in 10 years, $1806 in 20 years, and $2427 in 30 years. If rent was to rise by 5 percent, then it goes to $1628 in 10 years, $2526 in 20 years, and $4321 in 30 years. If monetary policy were to get of control, with too much money printing and inflation rose by 10 percent per year, then the rent becomes $2593 in 10 years, $6727 in 20 years, and $17,444 per month in 30 years. Many economists are expecting 3% to 5% annual rent growth over the next two years based on recent falling trends in apartment vacancy rates.
When rents rise, there is also a tendency for home prices to rise. Fundamentally, rent and home price would rise roughly in lock step – provided that home values do not contain bubbles and are back in line with their historical relationship to rents. The chart below shows the rent (based on rental rent component of the consumer price index) and NAR median home price trend with the index set at 100 in 1980. Well, today, home price and rent ratio are pretty much back to historically justifiable levels. So it is reasonable to presume that any rent increase will also at some point lead to equal gains in home values.
If home values were to rise 5 percent (under rent growth assumption of the same) then the home value would rise to $178,500, translating into a gain of $8,500 in housing equity in the first year. Subsequent cumulative gains over several years would be sizable, if the yearly 5 percent increases could be sustained. Nationally the annual average home price increases have been at around 4 to 6 percent each year. Even if by some strange event home value was not to increase one cent over the next 30 years, the home would be owned free-and-clear by the 30th year. (Or much sooner if the family makes additional principal payments)
One always has to mindful that all real estate is local. One cannot simply pick up a home from Detroit and plop it down in San Francisco to get a fast price appreciation. Therefore local conditions, figures, rent growth projections, and analysis will significantly vary.
Moreover, homeownership cost entails not only mortgage, but the additional costs in terms of property taxes, insurance, and money needed for maintenance and remodeling, though there are cost savings such as the mortgage interest deduction and property tax deduction for tax purposes that were not considered.
What is most important from my perspective is whether the family likes the home they are about to purchase and whether the family is willing to stay well within their budget. If these two criteria are met, then now may indeed be a good time to consider buying.
Source: National Association of Realtors®
Toby’s Commentary: Extrordinarily low home prices and interest rates cannot overcome overly stringent underwriting and appraisal standards or potential buyers’ lack of confidence in their own economic future. To date, over 50% of Flagler County’s June home sales have been cash transactions. That is why home sales have not recovered.
Rent
Of course, If I could time the market, I would be a billionaire….
Home prices are still declining, so how can today be better to buy than tomorrow?
I understand mortgage rates are incredibly low and it is a buyer’s market. But most statistics show another 10% drop this year alone.
The author forgot escrows for taxes and insurance and some sort of monthly amount for home maintenance – all items a renter does not pay.
Buy vs Rent
There can be little doubt that 5 years of steady home price declines has served to make many Americans hesitant to purchase a home. I completely understand this.
There are numerous factors at play, not the least of which is the tightening of credit pointed out by Toby in his response.
Folks, that statistic that 50% of sales in Flagler county YTD have been cash sales is incredible and no doubt unprecedented.
Now, on to some fundamentals. Real estate is a local business. I point this out because one person commented that real estate prices are expected to drop another 10% this year. Really? Does that mean that "starter homes", high end homes, condo’s, rural country homes, houses in Miami FL, houses in Utah, old houses and new houses, huge houses and tiny houses will all drop 10% this year? Will there be any house in America that will drop 10%? I’m sure there will be, but you simply can not make such broad statements about real estate. Most people understand that a 3 bedroom 2 bath house in Murfreesboro, Tennessee will sell for much less than an identical house in San Francisco, CA. It’s the old, "location, location, location" thing. It’s not the lumber that costs more in California, but the land.
The absolute "bottom" in real estate prices both nationally and locally will only be seen through "the rear view mirror" Just like we did not know that the first quarter of 2006 was the "peak" of housing prices until late 2008, we won’t know that we were at the bottom of the price cycle until at least 4 quarters of price gains. The mob is ALWAYS late. And it is true that it is impossible to consistently "time" the market.
I have worked for myself for the past 35 years. I have bought, sold, rehabbed, rented and managed real estate properties for more than 20 years. My father, who taught me the business did it for 45 years. I have met many very poor people and I have met many wealthy people. I have yet to meet a rich man who was not a home owner.
We have just gone through a real estate "crash" the likes of which I never in my wildest dreams would have believed possible. Have millions of people lost billions of dollars in real estate equity over the past 5 years? You better believe it. Every single property I own has dropped in value. While it has of course varied somewhat in it’s intensity from city to city, no part of America has escaped some significant price declines. I completely understand anyone being afraid to buy a house after such a catastrophic event. That is why I have no desire to even try to sell a house to anyone right now. All of my time, energy and effort is going toward BUYING them for myself right now. I say "buying", but in reality they are almost being given to me. In many markets houses are offered for sale for way below replacement costs.
While house prices in many markets are ridiculously low and interest rates are also ridiculously low, many young couples who would normally love to "move up" to a more expensive home can not, because they are unable to sell their current home. Many others may not be able to qualify for a loan under stricter underwriting guidelines.
If you are not able to take advantage of this unbelieveable buying opportunity that is indeed unfortunate.
But on the otherhand if you are a little older and you have some investment money available, or if you are young, have a good job, and can qualify for a loan, you can get the "deal of a lifetime" on some houses in some markets right now.
It is easier than it has EVER been. Simply find out how far residential building permits in your county have fallen over the past 5 years. Then find out how much the population in your county has has increased over the past 5 years.
Unfortunately, I never made it to college, but if a county almost completely stops building houses for an extended period of time while it’s population continues to incresae, that tells me there is very likely a housing SHORTAGE around the corner. If you can look at those two statistic’s and tell me that it is better to rent a house over the long term than to own one then I guess it’s true what they say. Truth really can be stranger than fiction.
missleading
Do not forget that the house has to pay taxes, insurance and maintenance to keep up, it is true on the long run will pay off but the completely picture has to be addedt to it.
10% drop
Well, since gotoby.com is basically a local website (bound to take off internationally ;-))…
My 10% focus was on, well…. our area.
I am sure I could point to countless articles, but here is one.
Daytona, Orlando, Lakeland areas all expected to drop 10% in 2011.
https://finance.yahoo.com/real-estate/article/111915/the-best-and-worst-cities-for-home-values-in-2011?mod=realestate-buy
So if we are talking about real estate in Flagler County, why would I buy today, June 11, if it might go down at least 5% more this year? I can sit back and wait another month, 3 month, or longer.
My gamble will be that interest rates will still be low, but the price of the home will be lower = a net savings.
We aren’t talking about homes in Idaho, Tennessee, or California.
Go to Zillow, which I think lags behind in data.
My house has dropped 7.3% since Jan 2011.
The unit my parents rent in Hammock has lost about 12% value this last 6 months alone.
How many more examples do we need?
I am not talking about trying to time the market exactly, but even short waits right now would most likely yield savings to a buyer.
And as soon as the mortgage lenders get wind that there is more buying activity, they will flood the market with their ghost inventory and then foreclose on more of the homes that are in lawsuit limbo.
reply
On some points…. Touche.
What I am getting at is this:
Just as I am saying to try to wait for the bottom, you might miss the bottom by months.
If you buy now, you will miss the bottom by months as well.
If not year(s), in both scenarios.
Reply to Lewis
You are correct about the writer leaving out some expense categories. But I don’t think that home prices are still going down; at least not in the local market. The inventory of homes for sale in Flagler County thru MLS has dropped 5% in the most recent 5 weeks while pending sales contracts rose 10.4%.
The pending contracts measure current activity. Closed sales are not reported until after closing, usually weeks or months after the contract is agreed upon by both parties. In other words, what we are seeing today in sales stats actually occurred much earlier.
Reply to Lewis
I’ll bet that if you look a little longer, you will find hundreds of articles that predict a continuing drop in housing prices. But you won’t find me writing any of them. I don’t follow Zillow. You use their numbers to claim your house and the unit rented by your parents both dropped. Dropped in what? Price? Are they listed for sale? Did someone buy them at the beginning of the year then sell them recently for a loss? I doubt it. As you said, Zillow lags. What is the point of looking at lagging information (based on estimates) when you have more current real transaction to guide you.
Zillow uses dated transaction information to extrapolate (guess) a hypothetical value for your home using primarily a per square footage comparison. No regard to condition, added features, upgrades, lot setting, etc.
The value of your home can only be determined by a ready and willing buyer.
My job is not to predict the past. Timing the bottom or pointing to an inflection point is not a science, but I believe I’m correct. Inventories continue to drop. Pending sales continue to rise. And Days on Market is shrinking.
Your claim that the banks will suddenly dump their shadow inventory on the market has some merit, but banks are not likely to react quickly. They haven’t done anything else in an expeditious manner.
Wait if you wish, but if you make your decisions by watching estimated derived from lagging data, you will miss the bottom by months. I stand by my observations and conclusions. My only caveat is the economy. If that goes potty, all bets are off.
In the end
In the end, it’s not whether or not you caught the bottom exactly. It’s whether or not you bought lower than you ultimately sell by a respectable margin.
I think most people underestimate the amount of cash on the sideline waiting for a reasonable investment opportunity. Real estate is that opportunity.
We are at the beginning of the next cycle of wealth creation. The downside risk today is not significant. The upside gains look really good.