Posted on 09/21/2007 10:49:53 PM PDT by Freedom_Is_Not_Free
Sep 17, 2007 -- When you rent, most people mistakenly assume the decision is made out of necessity, not rationality. But there is a very good reason to rent in today's bubble-stricken market: median incomes do not support median home prices.
By Ben W. (bdarbs)
Median income household cannot buy median priced home
The graph above demonstrates three very important facts.
* Whenever prices rise more than the normal trend, they eventually correct and drop back in line. * This housing bubble is an absolute giant when compared to the housing bubbles of the previous decades. * Income levels haven't come close to keeping up with home price inflation. For decades, home prices strongly correlated with median incomes. In 1997, everything changed.
What does this mean?
Now is perhaps the best time in US history to be a renter. You are far better off paying high rents for the next few years than buying a home and watching your equity disappear while the market takes a freefall.
Not convinced? Here's my argument...
The home prices that we are seeing today are artificial and not sustainable. This is because home prices have deviated from the fundamental formula that has always ruled the real estate market. Nationally, median home prices increased by nearly 50 percent in the last decade. The median income, on the other hand, has gone up 10 percent in the last ten years--a very meager increase compared to the change in home prices.
Incomes simply cannot support the bubble-inflated prices. In many places, Americans earning the median income have no chance of reasonably affording a median priced home with a conventional home loan.
(Excerpt) Read more at efinancedirectory.com ...
It can definitely be done, but you wouldn't want to live there.
Lots of places in the mid west. Depends what your looking for.
Expect to commute a ways.
Not within a hundred miles of Kansas City....
OK! Now I will respond. I pay less than 500 for a townhouse and it’s been that since my original contract. I have one neighbor just as quiet as me. (By the way, I live in a very beautiful part of the country). Patience is the key.
Yorkie - your answer, Part II. (Thank goodness for your double post... I get to answer twice.)
You asked what I would have in ten years after throwing my rent money away. I’ve been struggling with that question myself, which I will answer and then show you with gory math numbers...
First the answer: If I rent, my costs will be much lower than owning. I can invest this difference. So the real question is, financially, will I have more net worth with the appreciation on a home I own, or will I have more net worth by renting and taking the cost savings by not owning, and investing these savings in the stock market.
I performed exactly this analysis for a 15-year period and found that I would break even on a $220,000 house. So I should buy if I can get a home for $200,000 or less. $250,000 and over means, I lose money buying a home.
I can rent an apartment for $800 per month. I assumed rent would increase 5% per year.
I compared this with buying a $200,000 home.
I took into account the following costs...
$40,000 downpayment.
$4,800 closing costs ($3,100 after tax deduction)
$9,000 annual mortgage cost, after tax deduction
$2,500 per year property tax, increasing 2% per year
$1,000 per year homeowners insurance
$1,500 per year flood insurance (Sacramento is mostly flood plain)
Add to this...
$24,000 real estate commission when I sell the $400,000 home in 15 years.
$10,000 minimum in improvements over the 15 years of ownership
Note: I will still owe a $120,500 loan when I sell in 15 years...
As a homeowner, utilities like heat and cooling will cost double for a 1,500 square foot home compared to an 750 square foot apartment.
As a homeowner, I will have to pay for garbage, water and local tax assessments not required of a renter.
So you ask, what will I have at the end of 10 years. I’m looking at 15 years.
My cost to rent for 15 years is $220,000.
My net cost to own a home I buy for $200,000 is $80,000 if it doubles in value from $200,000 to $400,000.
By renting and investing the $40,000 down payment and the saving month over month by renting, if I got only an 8% return from the stock market, I would make a profit on my investment of $100,000, after paying about 40% in federal and state taxes. (I used 40% instead of 15% capital gains tax, because this is going to a tax-deferred 401(k) and when I take the money out in retirement, I believe it is taxed as normal income.
So...
$200,000 cost to rent.
- $100,000 investment return.
$100,000 is net cost to rent, vs. $80,000 net cost to own.
That is not a HUGE difference in cost. And with all the assumptions I made, who knows the true difference?
Will homes double in 15 years, just because they have historically? I don’t know?
Will rents rise 5% per year? I don’t know?
Will I only get 8% return on my stock market investments? I don’t know, but most people expect 10-11%, so I low-balled my expected return.
The point is, I need to buy a $200,000 home to make it financially worth buying vs. renting.
If you can find me a $200,000 home in a decent neighborhood in Sacramento, I’ll give you a 10% finders fee and a kiss besides.
You see... THAT IS THE ENTIRE PROBLEM.
It is not that I don’t want to buy a home or that it can’t be financially beneficial. When homes are still going for well over $250,000 and most near $300,000 in Sacramento, they are still far overpriced.
I make close to 6 figures, so it is not as though I can’t afford a $300,000 home. But the asking prices are WAY out of line with both incomes and rents. You can’t sell a home that people can’t afford to buy. 100,000 sellers can’t get 100,000 buyers to buy at these prices and the only solution is to lower prices. To that end, it makes more sense for me to rent, unless or until I can buy a home in Sacramento for around $225,000, tops.
Otherwise, it makes more financial sense for me to rent and invest the difference in the stock market.
So your suggestion that renting is always a waste of money is patently false. You have to compare your net expenditure renting vs. purchasing. At a certain price, rent is a waste of money. But when homes are too high compared with rent, then renting makes sense and buying is a waste of money.
If I can rent an apartment for $800 per month, that typical home in Sacramento the owner is asking $300,000 for is over 375 times monthly rent. It makes no sense to buy.
Even a home for $250,000 is 312 times rent, and still makes no economic sense to buy.
Renting is not always a waste of money. Not by a long shot. If I can’t buy a home in a decent neighborhood in Sacramento for $200,000 when home prices hit bottom, it is not going to make sense to buy when I can sock the difference away in my tax-deferred 401(k) plan for retirement.
If I am missing something here, please let me know. I don’t see where my assumptions are wrong, and I end up agreeing with the article I posted.
It all depends on location. You can’t assume that everywhere in the country is the same as what your local market is doing.
Some places are doing very well, others aren’t. You can’t compare anything on the west coast to something in say Grand Forks ND.
Yes, some markets are pretty tough, but if that’s where you want to live, you have to deal with that market. Like everywhere else, you have to shop around and learn it’s quirks.
By your description, condos should be cheap if they are overdeveloped. just wait until the dust settles.
Other states, you may find it hard to find a condo at all.
So does this mean average (median if you will) residential property taxes are also going down in rough proportion to home prices going down?
Very doubtful. We’re now going to get the worst of both worlds
Looking at some markets in some cities, sometimes it amazes me what people call an apartment/condo. People in New York pay $1200 a month for something smaller than my bedroom closet.
In fct my bedroom closet is a studeo by NY standards.
I’ve never seen taxes go down. Unless you see these overpriced houses really fall in prices like never before in history, I doubt they will.
I wonder how many of them have even been reassessed since the values doubled? That may be an interesting story to come.
I tend to agree with you, but I am not totally convinced that the correction in housing prices from the peak in 2005 will mirror prior corrections.
Appreciation was unprecedented. Debt is unprecedented. The use and volume of creative loans like ARMS, Jumbos, interest only loans is unprecedented. The use of 100% and even 120% loans is unprecedented. The extraction of equity as home prices rose through refinancing and 2nd mortgages was unprecedented.
I am really not sure we can model this housing bubble after prior bubbles after the confluence of so many variable that have never occurred before.
If housing flat crashes, I can’t say I will be surprised. I don’t expect it. It sounds like the author of the post does expect it. But I think the plunge in home values will be unprecedented due to all the unprecedented factors I mentioned above. This is just my opinion, but I’m not a voice in the wilderness.
And none of this takes into account the current liquidity crisis due to sub-prime loans, or possible raising of the Fed funds rate to fight severe inflation, which still could come to pass. If mortgage rates go back to 9 1/2%, that is flat going to KILL home values, because it will do the opposite that cheap, easy money did to get people into their current homes. The door will slam on home sales and housing starts, and it will be a long, long time before it opens, if we see mortgage rates return that high. It would be devastating to home prices.
There are plenty of places in the Midwest. The problem is you wouldn't want to live in those neighborhoods.
I’m surprised to hear you say buy next spring.
My home peaked in 1990 and did not reach it’s lowest value for 6 years. The person who bought my house in 1996, got it at its cheapest value.
Now you are saying that less than 3 years after the top of the bubble, it will be time to buy, despite the MASSIVE appreciation in values due to easy money, speculation, fraud, no down payment loans, 120% loans, interest only loans, ARMS, Jumbos, NINJAs.
Why? Why do you think housing will bottom next spring?
Sorry, didn't mean to touch a nerve.
I was just thinking of my own situation. When the wife and I went house hunting 8 years ago, I kept trying to get her to consider buying in the part of the county where you can still buy a livable home for under 50 thousand. Of course, she wouldn't go for it and we had to live in the more upscale end of the county.
It's all good, though. Good neighbors are worth buying.
I'd never buy anything in the spring, no matter what the market. You can bet that you'll pay the highest price of the year at that time. That's when people are most anxious to buy.
You can talk to me in the summer though, and I'll bet the market will be holding around Feb prices. We won't see much movement up or down for a while. Other than a few hot spots here and there, but not the national averages.
Unless there are a lot of job losses all of a sudden, and the entire economy goes sour, people are going to hang on and pay down debt.
Don't forget, the entire nation didn't go run out and buy new houses, only a small percentage of it did. they are a lot of people who are sitting in good poitions, have their houses almost paid off, or paid off, and will be spending cash as normal.
"OH, only if I'd bought that little house in that "not so bad neighborhood" twenty years ago."
Now that "not so bad neighborhood" is a stroll for crack whores.
"OH, only if I'd bought that little little place in the country twenty years ago."
The little place in the country is now being overrun by cookie cutter subdivisions, causing the property tax to almost equal the yearly mortgage payments.
I'd rather rent for now and let the land lord assume the pain in the ass upkeep expenses, while I save for the future.
My rent on a 1200 sq ft home is $500 mth, in a very quite but , high traffic neighborhood.
I know that last sentence probably doesn't make much sense but, trust me on this.
you don't live where I live.
Except for you SPATANBURG, S.C. FREEPERS!!!!
What's up?
See you at The Beacon, Saturday...errr, later today!
I work 2nd.
Please see my post #66. This is my exact conclusion. If I have to pay more than $225,000 for a home, with my income and tax bracket, vs. renting an apartment for $800 per month, I may be better off renting and investing the difference.
If I can’t buy a home for less than $300,000 in Sacramento, then I am certainly better off renting for $800/mo, even though rent will increase by 5% per year over the same duration.
Too many people think renting is a waste of money, when it is only a waste of money if rent is too high or if home prices are nice and low.
I agree.
Just ask anyone who paid off a home years ago, only to see property taxes and homeowners insurance skyrocket. Even after you hold the deed, the expenses keep on coming. Renters don’t pay this... Buying is not ALWAYS the best financial option.
Great points. I agree.
I will buy that condo with cash outright when the price approaches what it’s worth to me. Straight cash drops the price 20-30%. I will never have a big loan. Just little ones with a Visa and the usual bills. We really don’t need much to be happy.
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