Buy a House: It’s Much Cheaper Than Renting

Commentary about business and finance.
April 12 2012 12:37 PM

Buy a House Today!

With rents high and rising and interest rates low, today is a great time to buy a home—if you qualify.

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Alex Eben Meyer

They say that Joe Kennedy knew it was time to sell all his stocks when he started hearing tips from the shoe-shine boy. Thus a fortune was spared from the ravages of the Great Depression and the groundwork laid for a modern political dynasty. The point is what whatever “everyone” is doing, you want to do the reverse. Today, with homeownership rates steadily declining (PDF) and magazines like Forbes and the Atlantic claiming that young people aren’t into homeownership anymore the time is right to do the reverse. If you have the means, run to the nearest for-sale property and buy, buy, buy.

Of course, to many this is a song they’ve heard before, and they don’t want to listen to any bubble logic. Others are entranced by tales of “shadow inventory”—homes that are either bank-owned and held off the market or simply midway through the foreclosure process and waiting to be seized by lenders at the first sign of a rise in prices. According to this line of thought, house prices are basically immune to increases barring some much larger systematic resolution of the backlog of bad lending. Shadow homes are simply lurking out there, ready to join the supply pool as soon as buyers arrive, guaranteeing that sale prices will remain depressed.

That may be right, but it’s irrelevant to the new case for homeownership, which has nothing to do with resale value and everything to do with rents.

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As an illustrative example, consider the following from the complex where I live. In the rental portion of the facility, you can grab a 754-square-foot apartment for a minimum of $2,269 per month. In the condo portion, one door down, in a building also completed in 2008, an 868-square-foot apartment is selling for $419,900. That suggests that if you happened to have about $420,000 on hand, you could buy the condo and earn over $27,000 a year renting it out. That’s a yield of more than 6 percent on your investment purely out of rental income. You don’t need to worry about whether the unit will appreciate in price or not over time, just assume that thanks to inflation and population growth, you won’t see a sustained nominal decline in rents. That’s not a risk-free investment, but in the scheme of things it’s a great return on a pretty safe bet. For perspective, consider that Spanish government bonds yields getting up to 6 percent is considered cause for total panic. If you want to invest your $420,000 in U.S. government debt you’ll earn yourself yields that range from 3.13 percent on a 30-year bond to a mind-blowingly low 0.19 percent on a 1-year bond.

Now of course you probably don’t have $420,000 in cash sitting around in your desk drawer, but it’s a telling sign of the state of the market.

It’s similarly telling that interest rates for a standard 30-year fixed rate mortgage are running at just about 4 percent these days, meaning it’s cheaper to “rent” the money from a bank than rent the apartment from a developer. That suggests that even without having cash on hand, a person with a good credit rating could make a profit buying units and then turning around and renting them. Of course in practice that’d be a hassle, but if you’re not currently a homeowner, the moral of the story is that you could get the mortgage, buy the condo, and then “rent it to yourself” at a profit rather than renting an apartment.

Driving these price anomalies is a one-two punch of rising rents and declining mortgage eligibility. This, in turn, all has its origins in the financial crisis and continued risk aversion gripping the banking system. The subprime lending fiasco means that banks are now much stricter about who they’ll make a mortgage loan to. At the same time, the recession has battered people’s ability to repay debts. These two factors have made it harder for people to qualify for loans. At the same time, we’ve been building a record-low quantity of new housing units year after year since 2006, and many former homeowners are now back on the rental market after foreclosure. More people chasing a diminished stock of rental property means rising rents and great deals for those who can get a loan. Data from the real estate site Trulia suggests we’ve seen some truly eye-popping increases in asking rents around the country. Of the 100 largest metro area rental markets, only five, of which the largest is relatively small Las Vegas, saw year-on-year declines. During the same period, rents rose 6.2 percent in the New York area, 6.1 percent in Chicago, 4.1 percent in Houston, 4.9 percent in Dallas, 5.2 percent in Washington, 2.5 percent in Atlanta, a staggering 9.8 percent in Boston, and an amazing 12.8 percent in Miami. Los Angeles and Philadelphia round out the 10 biggest metro areas in America with small price increases. Across the 100 big metro areas, Trulia saw a 5 percent increase.  The upshot is that outside of San Francisco and Honolulu, the ratio of sale prices to annual rents is now below 15 in every American city, the price at which it generally becomes cheaper to buy.

Even more striking, in more than 70 markets the ratio is below 10. In some places like Detroit and the supercheap Ohio markets in Dayton, Cleveland, Toledo, and Akron, that may represent a plausible calculation that the area has entered a semipermanent period of population decline. But cities like Atlanta, Houston, Chicago, and Minneapolis are also incredibly cheap and by no means collapsing.

The basic problem is that the building stock doesn’t match our organizational knowledge. In principle, very rich or very creditworthy individuals or firms ought to be snapping up cheap homes and renting them to less creditworthy individuals who can’t take advantage of today’s low interest rates. Such actions should lower rents and raise sale prices, eliminating the anomaly. But nobody really has much experience with large-scale ownership of single-family homes as rental properties and the logistics of doing it seem bad. Nevertheless, some bold entrepreneurs are giving it a shot and the government is trying to encourage more. These are good ideas, but it’s not clear if they’ll work or how quickly. When it comes to taking advantage of great homebuying opportunities, there’s still no real substitute for the old-fashioned single household buying a home to live in. That’s what the entire mortgage lending and real estate industry in the United States is set up to support, it’s what our tax code is designed to encourage, and it’s exactly what you should be doing if you’re currently renting and qualify for a conventional mortgage.

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