Rent or Buy, a Matter of Lifestyle By DAVID LEONHARDT

May 10, 2011


Rent or Buy, a Matter of Lifestyle By DAVID LEONHARDT

WASHINGTON



Real estate agents across the country are aggressively making the case that now is a good time to buy a house. Mortgage rates are near record lows and will probably rise in coming years. Home prices may not be done falling, but they probably don’t have much further to go in most places either. Rents, on the other hand, seem set to increase, thanks to low vacancy rates.



“Renters beware,” warned a newsletter that I recently received from a real estate agents’ group.



Individually, each of these points is unobjectionable. But it’s important to remember the source. Real estate agents, like mortgage brokers and home builders, have a big financial stake in persuading people to buy homes. That’s why many agents are always pushing home buying, whatever the rationale of the moment happens to be.



The truth is that you can make just as strong a case in many places for renting. For starters, neither mortgage rates nor rents are likely to rise rapidly. Even more important, house prices, relative to rents, remain higher than their long-term average, especially in much of California, the Pacific Northwest and the New York region. In these places, among others, renting is often cheaper than buying — still.



I’ve made a near-annual habit in this column of looking at the rent-versus-buy decision, and The Times has built an online calculator so that readers can make their own comparisons. The idea isn’t only to help potential buyers but also to figure out whether and where house prices are overvalued. That question is of obvious importance to homeowners and to the American economy.



As this year’s spring buying season nears its peak, the relative merits of renting and buying are closer than they have been since the housing bubble began inflating almost a decade ago. So the best single piece of advice for most people is to make a decision based mainly on their stage of life, rather than on any complex financial calculations.



If you think you are ready to settle in one place for at least five years, if not more, buying often makes a lot of sense. That’s why I bought my first house, in the Washington area, a few years ago, despite thinking local prices remained high.



But if the chances are good that you will move again in the next few years, renting is usually the better bet. The various closing costs, including real estate agents’ fees, are just too high. Owning a house also makes it much harder to move when you want to because selling a house is complicated.



Within this basic framework, the numbers — specifically, something called rent ratios — are the next place to turn. A rent ratio is the sale price of a house divided by the annual cost of renting an equivalent house. When the ratio is below 15, most people should lean toward buying.



To see why, look at the Atlanta area, where the average ratio is now about 13. Combined with today’s low interest rates, that ratio means that the typical monthly mortgage payment is several hundred dollars lower than the rent on an equivalent house. Over time, this difference helps make up for the other costs of owning, like closing costs and borrowing costs. And, yes, a mortgage costs money, despite the tax deduction.



Only if home prices in Atlanta fall further and don’t recover for years would most buyers today have reason for regret. The other areas where the average ratio is below 15, according to Moody’s Analytics, include Los Angeles, Miami, Minneapolis, St. Louis, Las Vegas, Cleveland, Detroit, Phoenix, Pittsburgh and Tampa, Fla.



On the other end of the spectrum are metropolitan areas where prices still look bubbly. In San Diego, the ratio was 22 at the end of last year (and most ratios have fallen only slightly since then). In northern and central New Jersey, it was 25, and it was 29 in Manhattan. In Silicon Valley and the nearby East Bay in California, the ratio was above 30.



All these numbers are well down from their peaks from about five years ago. But they’re still higher than they were in the decades before the housing bubble. They are also high enough to make the monthly costs of owning steeper than the costs of renting.



As a rule of thumb, a ratio above roughly 20 means that a monthly mortgage bill is higher than rent for a similar house. In Silicon Valley, the after-tax mortgage payment on a typical house might be $3,500 — while the rent on the same house would be only about $2,500.



The arithmetic of owning then gets mighty tough. On top of closing costs and mortgage costs, owners are also falling further behind renters each month. To make up that ground, house prices would have to rise significantly over the next few years. Does that sound like a good bet?



When you look at the numbers this way, it’s easy to conclude that the excesses of the housing bubble are mostly gone in much of the country. Yet you also start wondering whether New York, San Francisco, Seattle and a few other places still have a housing crash in their future.



I realize there are some important caveats here. Affluent people tend to want to own their houses, even when the dollars don’t make sense, and the Northeast and West Coast are home to much more wealth than a few decades ago. That could cause future rent ratios to be higher than those in the 1990s or even the 1980s, a better decade for real estate. Meanwhile, the coming rise in rents — maybe 4 or 5 percent a year, for the next few years — will reduce rent ratios even if prices don’t fall.



Yet the fact remains that a lot of New Yorkers and Californians, among others, are paying a hefty premium for the privilege of owning. Eventually, some of them may decide it’s not worth it, much as homebuyers in Las Vegas, Phoenix and Florida ultimately decided that prices were too high. If that happens, prices in New York and California will fall, too.



A crash strikes me as unlikely. But any potential homebuyers should know that real estate exuberance — irrational exuberance, it seems — has survived in at least a few places.