If it’s cheaper to rent than to own, will people still buy houses?
The cost of ownership is rising and will soon outpace rents. Will buyers still want to purchase homes when it costs them more to do so?
During the hight of the insanity of the housing bubble, it cost nearly double to own a house than to rent it (assuming a conventionally amortized mortgage, which nobody was using). Despite the huge premium for ownership, people bought houses, several if they could. Being one of those cautious fools who never considered using any of those innovative loan products, I couldn’t understand why anyone would pay so much more to own than to rent. It never occurred to me that people paid so much because they believed they would make a return on that investment through appreciation alone. That was a Ponzi scheme, and I saw it for what it was.
Fortunately, I am not alone in grasping that insanity today. After the housing bust, even the most kool-aid intoxicated grudgingly admit real estate can and does go down in value at times. Once that fact becomes widely known and accepted, it isn’t easily forgotten. Kool-aid has a dampening effect on memory and judgment, but with as severe as the hangover from the last bust was, it isn’t time for Bloody Mary’s quite yet.
So the question is, once prices get pushed up to where it’s undeniably more expensive to own than to rent — and were are nearing that price point, how will buyers react? Will they drink the kool-aid and try to push prices even higher, or will they retreat to their rentals and turn their back on home ownership?
It’s now cheaper to rent than own.
Across a large swath of Southern California, owning a house has become less attractive financially in the wake of rapid home price gains last year, according to a new study.
The mortgage payment on a median-priced, three-bedroom would exceed the rent on a comparable property in Los Angeles, Orange and Ventura counties, according to a RealtyTrac analysis released Thursday, based on prices from the fourth quarter of 2013.
I don’t show the cost of ownership as exceeding the cost of rent yet, but it may if we have a spring rally (See: Spring house price rally may inflate new housing bubble)
Nationwide, there were only 29 large counties in that situation, including the Northern California counties of Santa Clara, Alameda and San Francisco. A year earlier, nowhere in Southern California was rent cheaper than monthly house payments.
In Los Angeles County, RealtyTrac reported, the monthly house payment for a median-priced three-bedroom was $1,987 — about $100 more expensive than fair market rent for a similar property, as calculated by the U.S. Department of Housing and Urban Development.
A year earlier, house payments were about $500 a month cheaper than rent.
The chart above clearly shows that rents were much higher than the cost of ownership a year ago, and two years ago it was a sizable discount to own.
The median price for a three-bedroom L.A. County house was $417,333 in the fourth quarter. The monthly house payment for such a home rose 40% compared with the fourth quarter of 2012.
To qualify to purchase such a house, a buyer would now need to make at least $95,389 annually, according to RealtyTrac. That’s about $42,000 more than the median-household income and $27,000 more than the income needed to buy the median house a year earlier. Foreclosure is the rabbit hole where some of these buyers end up in, from where a climb back would require excellent legal guidance.
The widening disparity between rent and home prices underscores a growing affordability crunch across the region. Real estate experts say the high costs, without corresponding income growth, have depressed sales.
“The cost of financed homeownership is becoming dangerously disconnected with still-stagnant median incomes,” RealtyTrac Vice President Daren Blomquist said in a statement.
Higher mortgage rates and swift price gains widened that gap, Blomquist said, attributing the steep price increases to “investors and other cash buyers who are not tethered to the typical affordability constraints.”
I wonder if Daren is reading the blog?
In its analysis, RealtyTrac used median sales prices from the fourth quarter of 2013 and assumed buyers put 20% down and received a 30-year fixed mortgage at 4.46%. The monthly house payment includes principal, interest, property taxes and maintenance and insurance costs. Tax breaks for home owners were factored in.
The potential for home price appreciation was not included in the analysis.
When I calculate the cost of ownership, I don’t project forward to consider inflation or appreciation. For one, it’s guesswork. Nobody has any idea what will happen to house prices, and to believe you can accurately predict where house prices will be five or ten years from now is hubris. Further, small variations in rates of appreciation make for huge differences when projecting into the future. The difference between a 3% rate of appreciation and a 4% rate of appreciation doesn’t sound like much, but it can amount to hundreds of thousands of dollars in 20 year’s time — it can make the difference between thinking a house is overvalued or undervalued.
Projecting the future simply adds additional layers of complexity to the calculation that renders the analysis meaningless. Now, if a potential buyer is looking for an intellectual justification for making an emotional purchase, and most people do, then they will project a high rate of appreciation to make themselves feel good about what they’re doing. Unfortunately, it’s a futile exercise in mental masturbation. It may make them feel good, and although they won’t go blind, they might go broke — just ask some 2005 and 2006 buyers how they feel now.