Apr102012
The new normal in housing: cheaper to own than to rent
Californian’s believe it’s supposed to cost more to own an home than to rent one. It’s one of the biggest misconceptions in real estate. It’s so deeply engrained that even the so-called experts don’t question it. Renting is supposed to be more expensive than owning. Renters have mobility and no responsibility for maintenance, insurance, taxes and other expenses. The main reason anyone would pay more to own than to rent is because they foolishly believe they will be financially compensated for ownership through appreciation. We all see how that is turning out.
HOUSING: ‘This is crazy’: Home ownership cheaper than renting
By ERIC WOLFF [email protected] — Posted: Saturday, April 7, 2012 6:00 pm
The housing market has gone cockeyed.
No, the market has returned to its natural, non-kool-aid intoxicated state.
Monthly payments on a house are now cheaper than hiring house inspection experts like White Horse Pest Management – Phoenix Bed Bug Exterminator, according to an analysis of county-supplied and Realtor data by the North County Times.
It’s also less expensive to own than to rent in many Orange County markets according to the OC Housing News.
In a traditional housing market, mortgage payments plus taxes come in much higher than house rents: A mortgage interest tax credit and a long-held preference for buying create demand such that people pay more for home ownership, and landlords must hold down rents to attract customers.
Nonsense. Only in California, and only due to kool-aid intoxication. The “long-held preference for buying” stems from people’s crazy beliefs about appreciation.
But after a foreclosure crisis began in 2007, locals became leery of buying a home, and many former homeowners no longer had the credit to get a mortgage. Investors bought those foreclosed houses and in many cases rented them out. But they couldn’t keep up with the demand, and rents for detached, single-family houses rose.
Meanwhile, prices for houses plummeted and interest rates fell below 4 percent, a 40-year low. The combination of factors has created a house market in North San Diego and Southwest Riverside county in which homeowners are getting a better deal than renters, at least after they’ve paid their down payment.
That’s exactly what happened. And it’s what should happen when the housing Ponzi Scheme unravels. It happened after the last two busts, and it will likely happen after the next one.
“I don’t think this has ever happened before,” said G.U. Krueger, a principal economist for HousingEcon.com. “It’s a function of the huge housing price collapse which has left a lot of people in the lurch.”
This guy writes drivel for the OC Register too. If he doesn’t think this has happened before, he obviously has not studied rental parity over time. House prices become less expensive to own than to rent after every bust. Those conditions are necessary to induce new buyers to enter the market and stabilize prices.
Or, as Carlsbad real estate agent Tyson Lund put it: “This is crazy.” …
No. This is normal.
From boom to bust and back
Dan Bogdanski, a teacher, and his wife bought a house in French Valley for $600,000 in 2005, when house prices peaked.
Then the crash hit: Between 2005 and 2009, prices in Southwest Riverside County fell 55 percent, and prices in North San Diego County fell 40 percent, according to data from the San Diego and Riverside county assessor’s offices. As a result of the rapid drop in price, foreclosures blossomed, with banks taking back 58,000 homes in North San Diego and Southwest Riverside counties between 2006 and 2011, according to data firm ForeclosureRadar. That period also saw a huge upswing in short sales, in which homeowners sold their properties for less than they were worth.
“A lot of people who lost their homes, they have to live somewhere. They’re basically going into the rental market,” Krueger said.
Bogdanski said he and his wife realized that with house values falling so fast and so many foreclosures around them, they wouldn’t be able to sell their house for a profit in the few years he had left of teaching before he retired.
In 2009, they stopped making payments and conducted a short sale for $300,000.
This sale doesn’t become a strategic default statistic, but what would you call it? This family realized there was no point in hanging on, so they got out of the property. I advocate strategic default for the very reasons this family sold. Their shortest path to equity was to get out of the house they occupied any way they could.
For three years, they rented a house in Murrieta for $1,650 a month before deciding they wanted to buy again. Bogdanski much prefers the control of owning his own home, but he would never have jumped back into the market if it didn’t make financial sense. Now he’s in escrow on another French Valley home, this one for $200,000, with 3.5 percent down and a 3.85 percent interest rate on a 30-year mortgage.
“Our house payment will be less than our rent,” Bogdanski said. “We’re purchasing this house with the intention of renting it at some point. The house has to be rentable and hopefully have positive cash flow.”
This guy’s credit came back enough he was able to purchase. Now, rather than being $250,000 underwater with no hope of equity in the next decade, he is buying near the bottom. By the time his former house reaches his purchase price, he will likely have $150,000 to $200,000 in equity. Timing the housing market is important.
The perception of risk has been heavily altered by central bank/govt interventions. Not only is the price mechanism completely broken but market participants continue to be defrauded. The next leg down will be brutal.
Just Oy…..
DeMarco gives preliminary support to principal reductions under HAMP
Federal Housing Finance Agency Acting Director Edward DeMarco said principal reductions done under larger incentive payments from the Treasury Department would save Fannie Mae and Freddie Mac enough money to begin an umbrella write-down program.
DeMarco released preliminary findings from an FHFA analysis in a speech at the Brookings Institute Tuesday. He stressed the findings were early, and the risk of strategic default was very real and could easily wipe out any benefit.
According to the early results of a potential pool of nearly 700,000 borrowers, Fannie and Freddie are expected to lose $63.7 billion on those loans if they are not modified. With the tripled incentive payments to reduce principal under the Home Affordable Modification Program, the losses would be $53.7 billion if some principal is forgiven, compared to $55.7 billion through forbearance.
The Treasury could potentially send $3.8 billion in incentive payments to Fannie and Freddie after redefaults are factored in. Based on net-present-value models, reducing the principal on significantly underwater mortgages would save the GSEs $1.7 billion, resulting in a $2.1 billion cost to taxpayers for the program.
“Because the Enterprises would receive the tripled incentive payments for principal forgiveness, PRA is better for the Enterprises [and] reduces Enterprise losses by $1.7 billion,” DeMarco said. (Click to expand)
But the FHFA is still concerned about moral hazard.
Three in four underwater Fannie and Freddie borrowers are still current. There is no modeling as of yet that could fully anticipate how many borrowers would default in order to get principal written down. DeMarco called them “strategic modifiers.”
The FHFA considered the sample of nearly 700,000 potential HAMP borrowers with an average $51,000 in principal forgiveness. If, they said, 5% are current borrowers still making payments but decide to fall into delinquency, the average loss per loan would $18,870 with the Treasury paying 63 cents to Fannie and Freddie for every dollar written down.
“This leads to the result that if about 90,000 borrowers decided to strategically modify the NPV benefits of $1.7 billion to the Enterprises would be eliminated,” DeMarco said.
But this implies 100% of these borrowers would be accepted through HAMP. If 25% of the borrowers went through such a program, or 172,750 homeowners, DeMarco said if only 20,000 were “strategic modifiers” then it would offset any cost to the GSEs.
There is also the problem of second liens.
DeMarco previously said such a principal reduction program would unfairly push borrowers to pay back these debts largely owned by the banks, making it another bailout. He said information on how many second liens are tied to GSE loans is still murky, but estimates show roughly 50% of underwater Fannie and Freddie mortgages have some third-party share of the credit risk, either a second lien or mortgage insurance.
“In the case of principal forgiveness the Enterprises’ bear all the losses of the write down and share the benefit of the lower probability of default with the third party. In the event of a subsequent foreclosure, the Enterprises’ bear all the losses of the write down and the third party realizes all the benefits of it before incurring losses, if any,” DeMarco said.
The Treasury said the 2MP initiative under HAMP allows servicers to write down principle on these second liens as well. DeMarco said in his speech said roughly 25% of GSE mortgages modified under HAMP have a second lien eligible for 2MP.
“Whether Fannie Mae or Freddie Mac forgive principal or not, the universe of Enterprise borrowers potentially eligible for a HAMP PRA is well less than one million households, a fraction of the estimated 11 million underwater borrowers in the country today,” DeMarco said. “The far larger group of underwater borrowers who today have remained faithful to paying their mortgage obligations are the much greater contingent risk to housing markets and to taxpayers. Encouraging their continued success could have a greater impact on the ultimate recovery of housing markets and cost to the taxpayers than the debate over which modification approach offered to troubled borrowers is preferable.”
“the risk of strategic default was very real and could easily wipe out any benefit.”
There is going to be a huge I-told-you-so in about six months to a year.
IR,
Most market forecasts are filled with double talk, inconsistent implications and vague to unknown jargon to do exactly like you said …’I-told-you-so” while being 95% wrong.
Rents are partially determined by the fixed cost of ownership and what the market and owner can bear. Lot’s of landlords have lean years that expenses are greater than rents. The hope of appreciation in RE and rents keeps them going and also a primary job to cover the loss. I know some who almost when BK and made a fortune, but more who just break even in rental property after a long dry spell and more professionals have lost large $.
Cost of ownership also includes liquidation cost and lack of liquidity. I wouldn’t buy unless I plan to stay for at least 5 years or the company will generously cover liquidation cost.
My crystal ball said that FHA’s PMI doesn’t stand a chance to cover the defaults. It just a plan to remove the liability from the banks and transfer liability to the taxpayers for Bailout III coming to Japan II (USA) soon.
I had a chuckle @ this article too, they act as this has never happened before when it’s historically been the norm. My parents bought their first house in Huntington Beach in 1962 while all their friends were renting because my Dad was thrifty and buying was cheaper back then. Not till the baby boomers came into the picture did the tables turn.
What will be interesting is how much these rumored REO bulk sales and the Irvine Company’s ramp up in rental unit production push rental prices down over the next few years. Will geater rental inventory reduce rental costs, I think so. What do you think the effect on sales prices will be?
If rents are hurt by the influx of new product, then prices will likely fall. Without the cost push of rising rents, there is little incentive to buy, particularly in places where prices are above rental parity.
realtors and lenders operating on a loan origination model have nothing to lose by lobbying the FHA for lower lending standards, so they are opposing a new rule which would prudently eliminate potential borrowers who are known default risks.
FHA Delaying Disputed Debt Rule Until July
The Federal Housing Administration (FHA) rule preventing potential borrowers with outstanding collections debt of $1,000 or more from getting an FHA-insured loan is on hold until July 1.
The rule, which many in the industry warn would prevent even more consumers from taking out a loan during a time when lending has tightened, took effect April 1, but will be delayed now until July 1, 2012, according to a notice issued by the FHA.
According to the FHA, the delay is to allow “[m]ortgagees additional time to adapt their procedures to implement portions of the new guidance.”
Before the effective date, FHA said it intends to seek additional input on the rule, which was created to lower default rates.
For lenders who assigned case numbers between April 1, 2012, and April 8, 2012, as long as the numbers were assigned according to either the old or new guidance, the actions will not be viewed as a violation of HUD requirements.
The new rule does include exceptions, such as debt disputed due to identity or credit card theft or if a hardship was faced such as death, divorce, or loss of employment.
FHA-insured loans accounted for 25 percent of the new market share in February, according to Ellie Mae’s Origination Insight Report. Overall, FHA currently has 4.8 million insured single family mortgages, the agency stated on its website.
How is this going to cost me as a tax payer later when FHA has larger than expected defaults?
Speaking of which, anybody knows what is going on with those proposed FHA fee increases (up to 2.05%) discussed the other week?
The rental market also needs to be cleared of all the ponzi borrowers now trying to rent out their houses at insane prices in order to cover their monthly costs. It’s pretty common in LA to see ponzis trying to get $6k/month for a 3/2 they bought at the peak for $1.2 million. The property taxes alone on those “investments” are enough to make even the most delusional ponzi lose sleep.
We’re considering becoming one of these! If we can just get a rate reduction or refi of our second via the National Mortgage Settlement in the next few months, we might consider renting-out our 3/3 townhouse. Then we’d just collect rent (breaking-even) sitting on a 120% LTV mortgage.
What will happen when all of the investment property buyers begin to gut each other with lower rental rates just to attract tenants? Dr. HB ran an article about the Las Vegas markets rental property glut and how many instant landlords are now offering free rent to any warm body who can lease a home. Could the same thing occur in the IE, then spread to lower cost areas like Stanton or Santa Ana? If so, what else might happen when REO rental homes begin to bubble through the supply chain? Might we start seeing another wave of strategic defaults of thinly capitalized investor/owners?
I am concerned about the impact the REO to rental program will have on rents. Hopefully, an improving economy and lower unemployment will put upward pressure on rents to counteract the supply pressures. If it doesn’t, and if rents start to fall, rental parity will decline along with it, and house prices will weaken further. The REO to rental program may take supply off the for-sale market, but it may also undermine affordability.
Hey Irvine Renter,
The finance reporter on Business Insider had the same ‘crazy’ story about renting being more expensive than buying. I wanted to correct him, but didn’t feel motivated. If he really wanted to learn, he can come visit your site. You’ve done a great job of laying out all of the needed tools to do an analysis yourself.
Mario.
Thanks, Mario. I’m glad you find the site valuable.
I’m glad people are learning that real estate has several negative financing factors when compared to other investments:
1. High carry cost (Property Tax/Interest Cost/HOA/Maintenance)
2. illiquidity (Loss of downpayment)
3. High leverage/High cost (especially in CA)
4. High transaction cost (Closing, realtor, appraisal, inspection etc)
5. Lack of diversification
This is in addition to the many reasons discussed in this site such as: income/price ratios, shadow inventory, interest rate risk, lack of mobility etc. We all need to get be realistic as to what the current incomes can sustain and what the future incomes might by like.
I find that you really need to be their to manage residential rental property from a distance and reoccurring cost of non-CA property taxes, insurance and maintenance goes up faster than rents. I already see large inflation for maintenance, especially on the HVAC and roofing.
Those maintenance/HOA/management fees are a killer and it is much easier to manage property when you are closer to your units, but there are some locations like (i.e. Vegas, Phoenix) where you can buy at auction for $75K-90K which equal to about a 10-12% CAP rate making the inconvenient trip several times a year worth it. I wish you can get 12-14% CAP rates in CA, but I don’t think its happening.
We will see the effects of inflation of goods and services to the cash flow models for all those units. When the price is right…there is always a buyer especially in a super-low yield environment, the FED is begging us to take more risk (equities, real estate etc).
“Renting is supposed to be more expensive than owning.”
Ummm, only in a low-inflation environment, or more exactly an environment with low inflationary (or deflationary) expectations.
Once you get past a couple of percent in persistent inflation, the fact that mortgages are nominal but house prices are real can have HUGE implications for the rent/buy breakeven. This is especially true when mortgage interest is tax deductible.
A lot of the wealth building of normal middle-class people during the 1970’s and 1980’s was in reality the forced savings resulting from paying the (high, here in Australia) nominal mortgage payments. I know my own parents went from 5% equity on purchase to 70% equity on sale (after dad died) in 10 years, by simply making the monthly payments on a 40-year loan.
What really angers me about the story of the older couple in French Valley is that they’ve managed to benefit from extraordinary market conditions to effectively default on their obligations … they gamed the system.
What do I mean? Well firstly, they bought a house they seemingly couldn’t afford because it appears from the data offered in the story they can afford roughly $1700/mo. That payment doesn’t cover a 30-yr note on a $600,000 house. We can infer they used an Option ARM for purchase number one. Secondly, they lived rent-free for some period of time while they engaged in a short-sale. Under normal conditions, stopping payments equals NOD and foreclosure shortly thereafter. Again, they gamed the system by taking advantage of unusual circumstances. Thirdly, and what angers me most, is they only waited it out a 2-3 years before their credit recovered and BINGO, they’re home-owners again. WTF!?
I thought the one side-effect that would provide some control over this kind of irrational behavior from re-occurring was that credit ratings would take a beating. Clearly not. That means every current squatter and HELOC abuser that has arguably benefitted HUGELY from this mess will again be part of the buying pool competing for homes with those of us who wisely and perhaps morally didn’t engage in this fraud. They’ll get booted from their current property, sit it out a year or two (anyone wanna bet its less than that?) then presto they’re right back in the “game” with every incentive to do the same thing all over again. I mean, what did they suffer? What did they learn? Simply this … overreach on housing because you’ll make artifically surpressed payments for several months, maybe a year or two, then stop making payments … squat for a couple years then repeat the cycle. Maybe even get lucky and pull some extra cash out of the bank in the process. I dunno … where’s the downside?