Saturday, December 03, 2005

Rents vs. Mortgage

Over on another blog there has been a discussion going on about how dislocated are mortgages and equivalent rents (i.e., the disparity between how much the monthly mortgage is for a house vs. how much the same house can be rented each month). This reminds me of a question left on this blog (which went unanswered) a little while ago that went something like (and I paraphrase) -- "Everyone is always comparing the median income for an area with the median price of a house in that area; why should we expect the median income of an area to be able to afford the median priced house in that area?" To me and I think to many who read this blog the answer to that question is patently obvious.

Someone then posted this comment which I feel pretty much sums it up:
"The thing about renting is, you actually have to have the monthly income to qualify to make the payments. There is no neg am, no IO, no payment option, no drawing down home equity to get by every month. Rents reflect what people are actually able to afford based on their monthly INCOME, which is why the rent/buy ratio is so out of whack in many places.

Lenders and the GSE's (and other buyers of MBS) have been so helpful in making homes "more affordable". They have allowed prices to continue to skyrocket when the income was not there to support the prices. Their idea of affordability was allowing the buyer to borrow too much, but keep the payments "affordable" with crazy financing, all while allowing purchases with little to no down. Or, make homes "affordable" by simply doing away with income qualifications. Allow people to take on any amount of debt they chose without any verification that they have the means to pay it back, because of course their home equity will bail them out down the road.

This does not make homes "affordable", it puts borrowers in precarious financial positions in the name of making a buck.

Why are high home prices a GOOD THING??? We don't like it when the prices of life's other necessities goes up. But, higher home prices, WHOOPEEE..."
Here you will find the rent vs. mortgage data I published earlier for Marin County. My calculations were deliberately very conservative. Even so, mortages in Marin are more than twice the equivalent rent. The real figure is probably more like three times. And here you will find a graph of housing affordability for Marin County up through 2004 that I published on this blog a while back (which reminds me that I will be able to add 2005's data soon).

Check out this rent vs. buy calculator. Very interesting. I plugged in Marin's mean house price of about $1,000,000, its equivalent rent, assumed a yearly house appreciation rate of 5% (which is what realtors say we can expect now that the market is "flattening"), realistic values for a 30 year fixed loan (20% down payment [i.e., $200,000], etc.), and a 35% income tax bracket. The results came back as "Your home purchase does not breakeven after 30 years" and 'you should consider continuing to rent'.


Anonymous Anonymous said...

Plus throw in the risk of carrying debt in an economic environment that appears to be inching towards recession and in a county that has no job growth (except realestate)(marin outsources its jobs from sf), and you have a situation that favors renting even more.

Dec 4, 2005, 5:52:00 PM  
Anonymous Anonymous said...

I plugged in my real data (i.e. a property I actually just sold that was rented out -- a 3 bedroom townhouse in Novato) and came out with home equity still outstripping investing the case elsewhere. Here were my inputs:
Price of home: $540k (sold value)
Cash on hand: I assumed 10% or $54k
Interest rate: 5.875, my actual non-owner occupied mortgage although with 70% LTV so not quite apples-to-apples as nobody does 90%LTV non-owner occupied loans.
Term: 30 years
Tax: 1.2%
Insurance: 0.05% (low because condo insurance only)
Loan origination: .5% (roughly in line with my loan costs)
Points: 0 (ditto)
Other closing: not sure, threw $4k in there.
Dues: $251
Monthly rent: $1775 (again actual, not hypothetical)
After tax investment return: 7% (and if you can get that in today's stock market you are doing very well)
Income tax rate: 34% (25%+9.3 state)
Inflation: 3.1%
Home apprecation: 5%
Sales commission: 5% (my actual commission on last transaction)

Click "Home equity versus investment". If I read the chart correctly, I will have $425k in home equity versus $290k by investing my money elsewhere. So, this is telling me that despite the loss of the use of that $54k plus the negative cash flow, I am still ahead by investing in real estate?

Dec 6, 2005, 10:28:00 AM  
Anonymous Anonymous said...

Also (I was anonymous poster above), you can also expect rents to start accelerating upward with more speed now that anyone who could purchased has purchased. Bay Area economy on the mend + unaffordable housing + continued (slow) population growth = rising rents. BTW, that $1775 rent I mentioned has been the same for that unit since 2001.

Dec 6, 2005, 10:34:00 AM  
Anonymous Anonymous said...

And you say a 5% increase in annual real estate value increase cited by the experts. But I don't think the experts are projecting 30 years into the future! There may be a few lean years, but over a 30 year period there are spurts of growth that are double digit year after year.

Dec 8, 2005, 10:13:00 PM  

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