It is now cheaper to buy a home than to rent in 98 of the 100 largest U.S. metropolitan areas. Years of post-bubble price declines, alongside stable or rising rents, have pushed down price-to-rent ratios across the country, according to Trulia’s Winter 2012 Rent vs Buy Index. The index tracks whether it is more affordable to rent or to buy a home by looking at asking prices on Trulia.com for rentals and for-sale homes with similar attributes in similar neighborhoods.
Deciding whether to buy or rent depends on personal factors, of course – like whether you have saved up enough for a down payment, can qualify for a mortgage and whether you plan to stay in your next home for at least five years. But the ratio of home prices to annualized rent (after adjusting for property attributes and neighborhood characteristics) shows the relative affordability of home-ownership. After factoring in mortgage rates, taxes, insurance, maintenance and others costs, here’s the rule-of-thumb: buying is cheaper when the price-to-rent ratio is less than 15, and renting is cheaper when the ratio is above 20; between 15 and 20, renting or buying could win out depending on how long you’ll stay put and which tax bracket you’re in for the mortgage interest deduction. Only Honolulu and San Francisco are in the “it-depends” range of 15-20, while all other metros are in the “buying is cheaper” range of 15 or less.
Even though buying beats renting in almost all metros, the price-to-rent ratios for each ranges all the way from 17 in San Francisco to less than 4 in Detroit – that’s a huge difference in the relative cost of buying across local markets. Variations in the price-to-rent ratios among metro areas follows clear patterns and reveal a lot about local housing markets.
Take at look at the national price-to-rent map. In the darkest green areas, mostly in the Midwest and South, buying is more affordable relative to renting; in lighter green areas, mostly in the Northeast, California, Florida and the Southwest, buying is still more affordable, but not as strongly. And in yellow areas – San Francisco and Honolulu -- buying and renting are comparable. Remember that we’re looking at buying relative to renting: this means that in addition to being expensive, period, home prices in the Northeast and California are expensive even relative to local rents, which are high in those markets to begin with.
What factors contribute to higher price-to-rent ratios in some metros? Surprise! It’s not the effect of the housing bubble. Metros where prices fell more during the bust don’t have either lower or higher price-to-rent ratios, on average, than other metros that weathered the bust better. Cleveland and New York, for example, saw similar price declines during the bust, but the price-to-rent ratios are high in New York and very low in Cleveland. In fact, of the metros where prices fell most from the height of the bubble – Las Vegas, Phoenix and many Florida metros - none make our top 10 list of metros with the lowest ratios.
Long-term fundamentals, not short-term changes in prices, determine which metros have high price-to-rent ratios. Although there’s no correlation between the price-to-rent ratio and price declines during the bust, the correlation between the price-to-rent ratio and price changes over the past 10 or 20 years are very high (.6 and .55, respectively). Similarly, the price-to-rent ratio is correlated with employment growth over the past five or 10 years, but not over the past year. Two other long-term factors that change slowly are also related to a higher price-to-rent ratio: high housing density and low vacancy rates.
What do these factors that explain the price-to-rent ratio all have in common? They all shape expectations about how local home prices will change in the future. Metros with long-term price growth (not just bubble-time growth) and long-term job growth will probably see continued housing demand growth. On the supply side, metros with low vacancy rates have less slack in the market, and those with high density have less room to build new housing – both of which mean tighter housing supply. Growing demand plus tight supply equals rising prices in the future. Future rising prices should affect the price-to-rent ratio because rising prices benefit homeowners but not renters. In markets where people expect prices to rise, home prices should be higher than other markets. All else being equal, people will pay more to buy (but not to rent) a home if they expect prices to rise in the future, which means the price-to-rent ratio should be higher.
The price-to-rent ratio therefore reflects people’s expectations about future price increases. But here’s what’s scary. There’s a positive correlation (.35) between the price-to-rent ratio and home-price volatility over the past 25 years. Even after controlling in a regression for those other factors that affect the price-to-rent ratio (long-term price growth, long-term job growth, vacancy rate and density), past price volatility has a positive, significant effect on the price-to-rent ratio. That’s a surprise: people should pay less for a risky investment for a given expected return. (Simple example: economists expect most people would prefer to get $10 guaranteed rather than having a 50/50 chance to get $20 or nothing.) Not when it comes to housing, apparently. People are willing to pay more to buy relative to renting in markets that have more risk (higher past volatility in home prices), even after adjusting for the expected return (the long-term average rate of home-price growth). If people are still willing to pay more for homes in risky housing markets, is the next bubble inevitable?
READ THE ENTIRE ARTICLE HERE: http://www.theatlanticcities.com/housing/2012/03/where-buy-and-where-rent-now/1545/