Businessweek Archives

Is this a buyer's market?


Much has been written recently, including the nice cover story in the latest issue of BusinessWeek by my colleagues Mara and Chris, about the degree to which homebuilders are dumping their inventory of built-but-unsold homes at fire-sale prices. Clearly, there are buyers who are willing to bet that we’ve hit bottom and that they’re scooping up incredible bargains.

But are they? To answer that question partly depends on what happens to the housing market going forward — does it stabilize and start climbing back or are further losses ahead. But this is the time to pull out those trusty “Rent vs. Own” calculators to run the numbers.

I’m sometimes skeptical of some of the financial calculators that are available for free on the Internet, mainly those “How Much Do You Need to Retire?” calculators provided by mutual funds and investment firms. That’s because the formulas are deliberately skewed in a way to make you feel you won’t have enough to retire and need to save more. And of course, Morgan Stanley or Fidelity Investments is happy to help (don’t take my observation here as a argument against saving. I’m well aware of the nation’s miserable savings rate.)

So before you use a calculator, be mindful of who created it. A homebuilder? A mortgage company? A non-profit. One calculator that I think is among the best, at least in terms of the number of inputs (the more the better) is one created by KJE Computer Solutions,which you can find by clicking here.

As for the market conditions in southern California, Dr. Housing Bubble has run the numbers himself and produced this analysis on his popular blog. And his conclusion: Despite the recent drop in prices in southern California, you’re still better off renting in many markets there. It’s still not even close. And I suspect in bubble markets like Washington D.C., Boston and south Florida, that’s going to be true for several more years.

Here’s a synopsis of Dr. Housing Bubble’s analysis:

The Good Doctor assumes our hypothetical buyer is looking to purchase a home in SoCal for $500,000 – in other words, a garden shed. The equivalent of a similar house that’s being offered for rent by its owner (probably someone who bought at the peak of the bubble and is underwater) is $2,200 a month. Buyer would put 5% down. And under the alternative scenario, the buyer rents instead and puts the down payment and the monthly “differential” – the difference between the rent and the $4,057 a month mortgage payment – into an investment earning 7%.

He assumes that the house appreciates an average of 2% a year, which he admits could be optimistic given that “many bears are predicting nominal losses in the double-digits.” But lets give housing bulls the benefit of the doubt for the moment.

After five years, here how the two alternatives stack up:

BUY: Amount of home equity is $56,379.

RENT: Value of that investment account is $106,843.

So it’s better to rent over a five-year horizon. And if home prices continue to decline, that $56k in home equity could be wiped out.

In fact, Dr. Housing Bubble concludes that you’d have to own the home for 17 YEARS before the return from homeownership would match that of renting-and-investing.

BUY: Amount of home equity is $320,859.

RENT: Value of that investment account is $324,517.

His conclusion?

Right now, against the propaganda machine of the housing industry, this is not the time to buy a home.

I wrote in this blog about a year ago that in 10 to 20 years you could have a new generation of homeowners who never understood why the previous generations looked at housing as "an investment." I stand by that statement.


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