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Is this a buyer's market?

Posted by: Dean Foust on October 10, 2007

sinking.jpgMuch 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.

Reader Comments


October 11, 2007 12:52 PM

You've provided yet another financial calculator. Individuals who understand the market and have basic common sense knows its still a terrible time to buy and will probably be for some time yet. Everyone else will have to choose between your financial calculator and those other financial calculators, and will probably make the wrong choice regardless. Financial calculations are useless when basic economic fundamentals can tell you all you need to know.

Happy Renter

October 11, 2007 1:16 PM

Excellent article. This is the first time in my life I've ever been "emotionally" satisfied being a renter, and it is mostly relief. I feel pity for people losing their shirts over this. And I watch various articles posted on that point fingers at the Fed, the realtors, the new home builders, the mortgage compaines, the appraisers, even fraud. Bottom line, the buyer completes the process.

Jim D

October 11, 2007 1:58 PM

In the south SFBay area, where I live, it was cheaper to buy a home than to rent, from day one, all the way back in... 1999.

Now, it's between 35% to 75% more expensive to buy, depending on your price point.

I find it unlikely that rents will go up by 50% in the next few years, absent absurd inflation. I also think that it will again be cheaper to buy than rent sometime soon.

The rest of the math is left as an exercise to the reader.

And I'd like to add one other thing - anyone who thinks this is a buyer's market is either quite young or has a very bad memory.

Buyer's markets feature things like having desperate sellers literally *begging* you to take the darn thing off their hands, and undercutting each other in "reverse bidding wars" that are breathtaking to behold.

Don't worry, when we're *really* in a buyer's market, you'll know it. There won't be any doubt in anyone's mind.


October 11, 2007 4:00 PM

First, I strongly agree prices are going much lower. I live in Boise, Idaho which had a strong run-up in housing prices, but to a mania level as in Florida or California.

Second, your examples assume the renter has a level of saving discipline that is rarely seen. It is oh so temptig to get that new BMW when you see your account becoming a tidy sum. I admit homeowners have done the same thing using readily available HELOC loans.
I still get the feeling the typical person has a better chance of building wealth in a home.

I think the coming key will be to refuse to listen to RE agent's line of crap, and be very aggressive in submitting LOW offers. They are required by law to submit all offers.

Good hunting!


October 11, 2007 4:25 PM

Personally, I never understood how houses could appreciate when all other consumer goods (that's all a house is) depreciate. Mind you, I graduated high school in 2001.

While living in Japan from 2002-2005, I saw the housing market there, were land values changed based on area, but the value of the house itself always went down. Because of that, besides rich people, manufactured homes were the prefered construction technique, quick, cheap, cost effective. People expected to sell their houses for less than what they bought it for, just like we do with cars, the only reason why prices were expensive was the land itsself (the rotary garage in Tokyo Drift is real).


October 11, 2007 5:39 PM

From the October 11th Wall Street Journal:

The mortgage mess is claiming a new group of victims: renters.

Across the country, a rising number of landlords are falling behind on mortgage payments, sending their properties into foreclosure, according to legal-services attorneys, local officials and financial experts -- and in many cases, their tenants are being forced out of their homes. Often, the tenants' first inkling of trouble occurs when they get a letter from the bank directing them to leave the premises.

"They just don't know what to do -- they leave town, move in with their mothers, end up in shelters," says Janet Merrill, an attorney with the Massachusetts Justice Project, a Worcester legal-services agency that runs a hotline for low-income people.

Tennison D

October 11, 2007 6:06 PM

GREAT article. Having battled the herd, countless conversations with Bay Area friends who think I'm mad for not having bought, especially since I've been "capable" the last couple of years, I feel vindicated by reading this.

Yes, renting indefinitely sometimes feels "unstable", but I've realized is psychological. My wife and I have managed to turn this feeling around by saving consciously, and doing fun things, like travelling. My landlord recently called, and knowing our financials, really wanted us to buy the house we rent from her, so she could be "free"..there have got to be many many like her...pity.


October 11, 2007 6:26 PM

Excellent. And very realistic.

Printing projections and evaluations made by mortgage brokers and real estate agents is pure propaganda and b/s. Thanks for keeping it real.

--Portland, OR


October 12, 2007 10:48 AM

All of here commenting have obviously done the "right" thing. We all thought for ourselves and saved our money not buying into these fantasy prices. It's a shame that the Fed will probably want to bail everyone out with our tax dollars. I live in NYC and house prices have doubled since 1999 while salary have, um, well, you get the picture...........

The only solutions to this problem are simple, either double my salary or let these banks and poor lenders take a bath. I'm hoping for 30-40% drop in NYC RE prices as this amount of decrease would be needed to make housing truly affordable in a real loan environment where credit history, income and assets truly matter, rather than the "give any idiot a jumbo-loan land" were currently living in.

Jeff Royce, RE/MAX Choice

October 14, 2007 12:42 PM

As you point out, you should check to see what biases are in calculators or an analysis before you believe what you read. I don't know Dr. Housing Bubble, but would guess that someone with a blog by that name would be trying to show that we are in a housing bubble.

There are two assumptions in this analysis that I would question. It seems to assume that over the periods described that rents will not go up. Over the long haul, especially over the 17 year period you describe, rents are likely to go up significantly.

Secondly, the assumption is made that housing costs will go up 2% a year, which you call bullish and optimistic. That may or may not be optimistic for 2008, but for a long period like 17 years it is extremely pessemistic. In my market in Northern Virginia, I have looked back on annual appreciation rates for different neighborhoods during different periods of time. Over any significant time frame I've looked at for actual neighborhoods, the appreciation has never been below 6% or over 8%.

I am unfamiliar with the Southern California market that you are working with, but would bet that the numbers are similar in many growing markets around the country. To find an area with growth as low as 2% for a significant period of time you would need to find an area where industry is dying and the number of jobs is shrinking. In Southern California and Northern Virginia, that is simply not the case.

The basic assumptions of an analysis will determine the outcome. On two of them, your analysis misses the mark significantly.


October 14, 2007 6:50 PM

Financial calculators are great you are correct this one is better than most.

In New Orleans, home owner's insurance is about 5 times what it is in other areas. So on a $350,000 home it is about $5000 per year.

Right now I rent an apartment for $700 which is incredibly low even for New Orleans. So if I bought a home I would probably end up paying $500 to $700 just in home owners insurance.

Oh and I can't buy insurance from any of the traditional companies. I can only buy from the State of Louisiana. So how suicidal do you think the numbers look when you add in those numbers. Well lets just say I am looking for a new apartment, the roof is leaking.

Buy, or wait?

October 15, 2007 9:24 PM

As a newly married couple looking to buy our first home in the North Scottsdale, AZ area. Our price range is the low 1M's. We have made several offers (such as offering 1M on a home listed for 1.2M that has been 300+ days on market) but find that many sellers and real estate agents pitch that Scottsdale is the 'Malibu' of AZ and is isolated from the price drops throughout other parts of the country. We have watched 2-3M homes sell for 1.6-1.8M, seemingly "great" deals for that price range. However, we have tracked very FEW 1.2-1.3M priced homes sell for even the 1-1.1M range. Agents react "shocked" at the 1M offer, as if it were very small-change. My question is this: Any advice on the 1M market-range? If this is considered a "luxury-home" market price range - does advice change on this market? We are looking for both a beautiful home that is also a conservative investment (4-6%). How are higher-end market conditions? Any forecasts? Are there any historical trends? We would greatly appreciate any comments, advice, discussions.

frustrated buyer in bay area

October 16, 2007 3:43 PM

Looking at the housing market national, then looking at the housing in SF bay area, the house with good school district still gets multiple offers, and the price still goes up.
Can anyone explain why the housing bubble, if it exists and I do feel it exists in bay area, is not burst up? When can we expect to see big drop in bay area?
If I've bought a good house 10 years ago, I'll be happy to stay inside without worrying bubble or not. Since I'm still looking for a good location, it's scary to buy now, but it's even scary to think about the price may go up again if I don't buy now, or the house market crash after I buy now. Any good analysis for SF bay area?


October 17, 2007 6:49 PM

Mr. Royce: I agree, someone holding a house for 17 years is unlikely to experience 2% real annual growth. That's because 17 years is about 1.5 normal real estate cycles - this person will either buy at a trough and sell at a peak, or vice versa, with a full cycle in between, and that isn't long enough for the REALLY long term trend to outweigh the fluctuations.

(Note: in terms of the real estate cycle, the period from 1995 to 1999 was weird. It didn't belong there, in fact it doesn't belong anywhere.)

However, averaging the likely results, 2% is about right. And there are places where we can look at a house's sales history for a couple hundred years; again, 2% is about right. (Remember, this is real, inflation-adjusted, that I am talking about.)

Buy or Wait: wait. Arizona is frequently mentioned as a bubble state. Based on past behavior, I expect that a good many cities will see a bottom in late 2009 to early 2011 at about half off their inflation-adjusted peaks and maybe worse. Separately, a rule of thumb indicates that Seattle (where I live) ought to see about a 50% real decline - and that's assuming rents go up 25% - but this rule doesn't provide a timeframe.

Also, this will give you more time to build up your down payment as lenders become somewhat sane for a while.

As for the house being an investment: see comments above on long-term growth rates. Once you buy, watch prices; when they've been shooting up for four years in a row, sell and go back to living in a rental (or in a bubble-less area).

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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