Housing: Time to Buy?

Good news: It's now cheaper to buy a home than rent one in 98 of the 100 largest American cities, according to real estate site Trulia.com.

Between plunging home prices, mortgage rates at all-time lows, and rents starting to rise considerably in some cities, nationwide price-to-rent ratios are now below pre-bubble levels. As a rough rule of thumb, buying becomes preferable to renting when the ratio of home prices to annual rents fall below 15, and vice versa. Here's where we are today:

Sources: Bureau of Labor Statistics, S&P Case-Shiller, author's calculations.

Like any real estate statistic, nationwide numbers don't mean much. What matters is where you live. Interestingly, though, after crunching the numbers, Trulia found that price-to-rent ratios favor buying in every major U.S. city except Honolulu and San Francisco.

Among those where buying is most favorable:

City

Price-to-Rent Ratio

Detroit 3.7
Oklahoma City 4.3
Dayton, Ohio 4.8
Troy, Mich. 5.4
Toledo, Ohio 6.0
Grand Rapids, Mich. 6.1
Cleveland 6.2

Source: Trulia.com.

Even in cities where renting still favors buying, the gap isn't big. The worst, Honolulu, had a price-to-rent ratio of 17. San Francisco came in at 15.5. Even New York is now 14.5, favoring buying over renting just slightly.

One of the big factors moving these numbers is rising rental prices. "Median rents rose 3% from January 2011 to January of this year, while home values fell 4.6% during that period," The Wall Street Journal wrote last week. According to Zillow's Rent Index, 69.2% of metropolitan areas saw rental prices rise last year, while only 7.2% saw home prices rise.

Those are the numbers. So should you rent or buy?

That's a more complicated question than some make it out to be. Beyond playing the "can-I-afford-it" game, I think you should ask yourself two questions before deciding whether to rent or buy:

1. How long will I stay in one place?
A typical mortgage lasts 30 years, but the average homeowner sells after about eight. That changes the ownership dynamic in a big way.

The way mortgages amortize, or are paid off over time, combined with short periods of ownership means the vast majority of an average American's mortgage payment goes toward interest, not principal. On a 30-year mortgage at 6% interest, 83% of your monthly payment goes to interest in the first year. By year five, it's 77%. At year 10, still 70% goes to interest.

The tax deductibility of mortgage interest is a benefit, but I think many homeowners overestimate how much equity they're building in their homes. Unless you can reasonably expect to live in the same home for perhaps 10 years or more, the financial benefits of owning are questionable, particularly once transaction costs, real estate fees, taxes, and upkeep are factored in. People overlooked this in the past because they could count on seeing home values go up 10% to 20% a year. That's not the case anymore. You have to think long term.

2. What kind of life do I want?
This is more emotional than analytical, but I think it's important. Late last year I interviewed Yale economist and housing expert Robert Shiller. When asked who should buy a home, he advised treating it as less a profit-seeking endeavor and more a lifestyle choice:

Basically, if I were in the market right now because I wanted a house, I would buy a house. I think most people have a sense of what kind of life they want to live and where they want their family and where they want their kids to go to school. It depends on your position in life and what you are thinking, but quite likely you are living in a neighborhood with a street, with sidewalks, with a playground nearby, a school that's convenient, and you end up buying a house because you want those things. I wouldn't let speculative concerns dominate that decision.

Adjusted for inflation, home prices were flat for almost then entire 20th century. Searching through more than 100 years of newspaper archives, Shiller found almost no discussion about even the prospect of rising home prices. It just wasn't on people's minds. "One expected to buy a home as part of normal living, and didn't think to worry about what would happen to the price of homes," he wrote in his 2004 book Irrational Exuberance.

Most of us would be better off with that kind of mind-set. Price-to-rent ratios now favor buying. That's great! But don't let it push you back into an "I-must-buy-now" mentality. Homes are not a place to make money. They're a place to live.

Disagree? Sound off in the comments section below.

Follow Fool contributor Morgan Housel on Twitter, where he goes by @TMFHousel. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (7) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 27, 2012, at 10:56 PM, Chilaw wrote:

    One problem with the rent vs. buy debate is that there are usually few good rental options if you want a 3-4 bdrm, 3 bath, suburban house, near a park, with good schools. You might have 50 buy options within your parameters, and only a couple of rent options. Buy vs. rent in many locations is a proxy for House vs. Apartment.

    The urban condo vs. apartment comparison is probably most relevant for the price-to-rent ratio.

  • Report this Comment On March 28, 2012, at 10:39 AM, DonkeyJunk wrote:

    Ouch, Ohio and Michigan.

  • Report this Comment On March 28, 2012, at 12:28 PM, JenniferDuBois wrote:

    We, at Realtor.com, agree with your thoughts completely. It is our mission to “empower people to love where they live.” We recently did a housing survey, and to your point. 94.1% believe their family must be happy in their home, and 75.1% said that their home defines them and is part of who they are. This is especially true when you think about all of the celebrations and traditions that we all enjoy at home.

    Jennifer DuBois

    Realtor.com

  • Report this Comment On March 28, 2012, at 12:58 PM, duuude1 wrote:

    And I have to respectfully disagree with you, Morgan and Realtor.com.

    Satisfy the needs first - then satisfy the wants.

    We all NEED to ensure financial security first - as boring and painful as eating your broccoli as that sounds.

    Once the financial security is in great shape - then work on the wants - like I WANT to have a nice house in the suburbs...

    But if satisfying your WANTS puts your kids college education and your own retirement plans in jeopardy - it is not only short-sighted - but foolish - and stupid - to focus on buying a house before establishing your finances.

    Like AAPL or GOOG or INTC or MSFT - make sure your balance sheets are ROCK solid - your future income streams are reliable - and then go ahead and splurge on the nice-to-haves like a nice white picket fence...

    Best,

    broccoli-eating Duuude1

  • Report this Comment On March 28, 2012, at 1:31 PM, TMFMorgan wrote:

    I don't think your point contradicts anything written in this article, duuude1

  • Report this Comment On March 29, 2012, at 11:01 AM, Chontichajim wrote:

    Your two questions at the end are the most important part of the article to me. While rents will continue to rise in the medium term it still doesn't look like a good move to buy for a period of 8 or fewer years. That sort of brings up the second question and if you really have a place you want and want to stay there long term buying looks better than renting.

    I do agree with "Chilaw" that choosing rental means accepting less space in a condo or apartment, but this also should reduce commutes and in some cases allow you to afford areas with better schools where SFH in the same neighborhood are out of reach.

  • Report this Comment On March 29, 2012, at 11:21 AM, TheDufer wrote:

    Or buy a multifamily home and let your tenants pay off your mortgage/interest, once you out grow or find something you like more, rent your unit out and make a profit. Simple idea that a lot of us young people dont't even consider.

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