Each month before I prepare the OCHN market newsletter, I think about ways I can improve it and deliver more value to users. This month, I added a new metric to the report that I believe provides a more intuitive way to look at the current state of the market. I applied the mortgage interest rate to the median home price to backward calculate the monthly cost of ownership for the market. I like this approach because it returns a number immediately comparable to rent.
When I first thought about this indicator, I didn’t think it would reveal anything of value. It’s basically the inverse of the rental parity calculation I already perform. I was wrong. When I plotted out the result, I was astounded to find that the monthly cost of ownership reveals much more about what’s going on than charts of median home prices and rental parity. The first thing I noticed was that the current monthly cost of ownership is comparable to what buyers were paying back at the peak of the late 80s bubble. That shocked me.
The implications of this are eye-opening. If the cost of ownership is the same today as it was in 1989, then all appreciation over the last 23 years is due to a decline in interest rates from 10.77% in April 1989 to 3.5% in October 2012.
Let that sink in for a moment. In April of 1989, the median home price in Orange County, California, was $206,000. With a 10.77% interest rate, the monthly cost of ownership on a median priced home was $1,926 per month. In October of 2012, the median home price in Orange County, California, was $428,000. With a 3.5% interest rate, the monthly cost of ownership on a median priced home was $1,922 per month.
Twenty three years later, and the monthly cost of ownership is the same despite home prices being more than two times higher. Appreciation in California is a bi-product of federal reserve interest rate policies and ever-decreasing mortgage interest rates.
The other very powerful tool this analysis provides is the ability to easily compare the cost of ownership to the cost of a rental. Comparing the median home price to rental parity also does this but in a less intuitive manner. The charts below show both views of the market. The top chart shows median home prices, rental parity, and the historically predictive relationship between the two. The bottom chart shows the monthly cost of ownership and the median rent.
Seeing the long-term cost of rental compared to the cost of ownership, it becomes obvious when it was wise to buy and when it was wise to rent. Whenever the cost of ownership breaks its tether to rents, a price bubble is inflated that inevitably leads to a crash. Armed with this information, I hope future buyers will be less prone to overpay and buy into a frenzy. There will always be fools who think it will be “different this time,” but it never is.
At the bottom of each page of the report, I have a graph of the median market rent with a line also showing the current cost of ownership. You can see if the cost of ownership is higher or lower than the cost of a rental, and you can see the trend over the last year.
Another thing that jumped out at me when I first did this study was that despite rising house prices, the cost of ownership is still going down in many markets. The impact of rising prices is being cancelled out by falling interest rates. I know many people are worried about missing the bottom or being priced out due to the lack of available inventory. Though the lack of inventory is frustrating, and it is causing prices to rise, the cost of ownership is not rising, so nobody is being priced out of the market. In fact, with the cost of ownership at 1989 levels and below rental parity, houses are as affordable as they have ever been in Orange County.
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