Falling prices makes the rent-versus-buy decision difficult
Back when real estate always went up — or at least when that was a commonly accepted as fact — the rent-versus-buy decision wasn’t primarily financially or investment oriented. Most often people would chose to rent instead of own because they valued mobility, didn’t want the liability and responsibility of home ownership and maintenance, or a variety of other reasons. Until the market crashed, renters did not consider losing their down payment and more if they need to sell unexpectedly. Much to the chagrin of realtors, potential buyers now know crashes are possible.
Deciding used to be simple—buying a home always made sense. Then the bubble burst.
By Alina Tugend — Wednesday, March 16, 2011
Jean Sica-Lieber owned homes all of her life—when she was married and divorced, when her children were young and when they were grown. But recently, after selling her Rochester, N.Y., town house at a loss, she decided to rent. Sica-Lieber assumed it would be for a year and then she would buy a small place with a garden. But now, she’s rethinking that plan.
“Part of me, and I think this exists in most Americans, wants to be a property owner, despite the fact that unless we buy outright, the bank really owns most of it,” the 58-year-old publishing specialist said.
There are some people who get it. Equity is ownership. Negative equity is an oxymoron invented by the lending industry who preferred a nonsense term that made money-renters feel like home owners.
“But when it came right down to it, I’m single and don’t have children to do chores. How do I want to spend my time? Would I rather do more travel or pay property taxes?”
She recognizes the opportunity cost of loan ownership. Without HELOC money to supplement income, high debt-to-income ratio living is a real drag.
So Sica-Lieber decided to hold off on buying that little house, and she renewed her lease on her town house for at least another year.
For Kelly Stettner, 41, who had rented all her adult life, buying a house brought unexpected joy. When their landlord put the duplex she and her husband were renting up for sale, they ended up purchasing a 1929 bungalow on an acre in Springfield, Vt. They, their two children, and their dog couldn’t be happier.
“Budgeting is different, but we’re exploring many options that we never had considered while renting—a solar panel, a vegetable garden, [do-it-yourself] landscaping, and much more,” said Stettner, an administrative assistant. “But the emotional end is what I couldn’t imagine. There’s a self-esteem from the responsibility of owning it. We’re responsible for keeping it energy-efficient, keeping it clean. We get to do what we want, when we want, on our own terms, and we directly benefit from it. That was something I hadn’t really anticipated.”
Those are the emotional payoffs of home ownership — or at least the perception of home ownership minus the inconvenient reality of debt. When people feel ownership of something, they tend to take better care of it.
For example, I recently moved to a different rental (I am still Irvine Renter), and this property has beautiful wood floors. I so enjoy the beauty of these floors that I take care of them as if i were an owner. I am caring for the floors because I appreciate their beauty. I get the benefit of use, so I feel and act like an owner even though I merely rent. I take better care of the floors in my rental because I feel that emotional sense of ownership.
I haven’t owned my primary residence for over 10 years now. I never thought that would happen, and I do miss many aspects of home ownership. Unfortunately, the reality of local price declines and the still staggering cost makes me stay on the sidelines. I can see the stars and moon aligning sometime in the next two or three years. I feel no urgency.
To buy or to rent? That was never much of a question for most Americans. Buy as soon as possible, of course, to show that you’ve grown up and made good. Paying rent, the thinking went, is just throwing money away; owning a house is an investment in the future.
It amazing how much those myths are embedded in our culture.
Until the past few years, that is, when too many Americans who bought homes with too little down and at too high a price discovered that they couldn’t pay the mortgage and couldn’t sell either. That unaffordable house became an albatross. So now, potential homeowners are more likely to seriously consider renting. But which makes more economic sense in the short- and long-term?
In nearly three-fourths of the nation’s top 50 cities, it is better to buy than to rent, according to the real-estate website Trulia.com. The site, one of the most popular for real-estate research, offers a “Rent versus Buy” calculator that compares the costs of two-bedroom apartments, condominiums, and town houses. The data for January show that cities where the housing bubble burst with a vengeance—Miami; Las Vegas; Arlington, Texas; Mesa and Phoenix, Ariz.; and Jacksonville, Fla., in that order—were the best places to buy instead of rent.
Renting was a far better deal in New York City; Seattle; Kansas City, Mo.; San Francisco; Memphis, Tenn.; and Los Angeles—less because of cheap rent than the continued high cost of buying in those cities despite the recession, according to Tara-Nicholle Nelson, Trulia’s consumer educator.
The website considers a home to be fairly valued, Nelson explained, if buying it costs about 15 times a year’s rent. So if you pay $10,000 a year to rent, you should be wary of paying more than $150,000 to purchase an equivalent piece of property.
The comparative advantages of buying versus renting aren’t easy to figure, though. Numerous websites offer calculators that have the user enter the requisite data and supposedly learn which course to pursue. But Russell James, who teaches personal finance at Texas Tech University, has researched these online tools and found them unreliable. When he plugged the same information into the top 10 online calculators, eight advised him to buy and two told him to rent. “At one extreme, I was told buying would save me around $61,500,” he reported, “and at the other end, I was told renting would save me $15,000.”
We developed the IHB calculator because most of the online calculators are intentionally misleading. Most rent-versus-buy calculators were not designed to give people accurate information. Most of these calculators were designed by realtors with the intention to present buying in a favorable light no matter the truth. It part of the ongoing campaign by realtors to dupe buyers into action — even if buying is harmful to the buyer — to generate sales commissions.
We are planning an upgrade to the IHB calculator this year. We may go high tech. I believe it can be a very useful tool if it can be streamlined for easier use and to present accurate information as clearly as possible.
James also warned that online calculators may be particularly misleading for lower-income buyers, who are more likely to purchase older homes that need repairs and are less energy-efficient. These buyers are also less likely to itemize their tax deductions, losing the advantage of the federal tax break for mortgages.
Whether you rent or buy, some costs may not be obvious. Homeowners must pay property taxes, private mortgage insurance (if they plunked down less than 20 percent when they bought), home insurance, and all utilities—some of which landlords may have paid before. They’re also responsible for buying any needed big-ticket items such as lawn mowers, snowblowers, and washer/dryers. Renters, Nelson said, face the “opportunity cost” of lost equity and the prospect of never owning a home free and clear; they also could pay substantially higher taxes if their income is large enough to deduct property taxes and mortgage interest. And any improvements a tenant makes to a rental property belong to the landlord, of course. Tenants might also face unexpected rent hikes and evictions.
The sad reality is most new homeowners underestimate their monthly costs by 20% to 30%. The most difficult period for most first-time buyers is the first year or two when they adjust to what their house really costs.
Real-estate experts warn that it’s important for potential homebuyers to plan ahead. The common wisdom is that a buyer should anticipate staying in a house for seven to 10 years to recover all the costs. Yet these days, most people expect to be more mobile, in pursuit of new jobs and careers. “The two things are working in opposition,” Nelson said, “the mobility of the job market versus how tough it is to recoup housing costs.”
An astute observer noted I have stated several times — perhaps too many times — people should expect to hold for seven to ten years to break even. Fair enough, but it is a message worth repeating, because most in Orange County real estate are still telling people rapid appreciation awaits those who buy today.
For buyers, times are very different than they were before the housing crash triggered the Great Recession. Then, the saying went, you just needed a pulse to get a mortgage. Now, you need a pristine credit score (in the high 600s, at least) and history without any outstanding debt or defaults, according to broker Allyson Bernard, the owner of Real Estate Professionals of Connecticut. And expect to put down at least 10 percent.
Many people who want prices to go back up quickly have complained about the tightening credit. I believe credit will tighten further and become more expensive going forward. The comment above reflects the current “bar” people must reach to buy a home. A FICO in the high 600s and 10% down is not onerous by historic standards.
Many in the lending industry have equated lower lending standards with progress. We are somehow going back to the stone ages of the 1970s by raising lending standards. Progress should not measured by how stupid banks can be with giving out free money to people who won’t pay it back. Relaxed lending standards do not reflect progress, they reflect regression and stupidity.
Lenders, she noted, also demand a strong employment history: “[They’re] not just looking at your stability, but at the stability of the market you work in.” The restrictions are toughest, Bernard said, on the increasing numbers of self-employed, who find it harder and harder to obtain a “non-verified” mortgage. Bernard noted that she owns her home, but that if she didn’t, as a self-employed real-estate agent, “I couldn’t even get a mortgage.”
When stated-income became the easiest conduit for Wall Street money, those programs were doomed. In many instances, we have probably thrown out the baby with the bath water when it comes to stated-income loans.
Some version of stated-income can be underwritten successfully. There are many ways the self-employed can demonstrate income, and programs using these sources as documentation will eventually return. However, right now, if you don’t get a W-2, it is very difficult to provide lenders with income documentation they will accept. We should never return to the days of signature mortgages, but programs that accommodate alternate sources of income can and will return to the market in time.
Still, now that housing prices are down and interest rates are low, many economists and most real-estate agents say that if you can find the credit, this is the time to buy. But Elizabeth Weintraub, a Sacramento agent who writes on the subject for the website About.com, isn’t so sure. “People think owning a home is their destiny, but maybe you’re not cut out to be a homeowner,” she said. “You’re making a commitment to buy more than four walls and a roof. You need to think, ‘Do I have a maintenance account set up? Will the tax consequences be significant? Can I afford to make improvements?’
“It’s OK to give yourself permission not to own a home,” Weintraub concluded.
That is the most important statement in the article. Prior to the collapse of the housing bubble, renting was universally derided as a sub-standard way of life. A tremendous amount of emotional baggage is attached to our desires to be home owners. Sometimes people just need to be given permission, the comfort of the herd, to make a change. The whole point of this article was to prepare people to emotionally accept the statement above.
By some accounts, the traditional stigma against renting is easing. There is even a small movement, Nelson of Trulia.com pointed out, of people who call themselves renters by choice.
Perhaps Irvine Renter is the start of a small national movement?
Texas Tech’s James, however, said he doesn’t expect any significant shift, partly because of Americans’ long-standing love for homeownership and partly because of the law. In Europe, where longtime renting is far more common, he noted, “there’s a totally different attitude.” Renters have strong legal protection—too strong, some argue—against eviction and dramatic rent increases. But in the United States, except in places (such as Manhattan) with a semblance of rent control, the cost of renting is unstable, he said, and therefore less appealing over the long haul.
That truism is only factual when borrowers use fixed-rate mortgages. ARM borrowers do not gain the certainty of costs lower than renting that fixed-rate mortgage borrowers gain.
Still, in deciding whether to rent or buy, the numbers matter only so much. Kelly Stettner regards owning a home in her Vermont town as good not only for her family but for the community, too. “It really does make us better citizens,” she said. “We’re responsible for keeping up good relations with our neighbors and making sure that our house looks good from the street.”
What does it say about her that she is a lesser citizen when she rents?
Upstate New York renter Jean Sica-Lieber thinks that the decision depends on where you are in life and what you want out of your future. “There’s a freedom that goes with owning,” she said. “And there’s a freedom that goes with not owning.”
The author writes the ShortCuts column for The New York Times. Her book, Better by Mistake, is being published this month. She’s at twitter.com/@atugend.
Freedom is renting. Given my new line of work, I strongly considered moving to Las Vegas. Since I rent, that is an option for me. A quarter to a third of home owners in America do not have the same freedom, and many of those people will not regain their freedom for a very long time.