From Austin to Boston, Renting Is a Better Deal
(Bloomberg Opinion) -- Most people make the mistake of evaluating the housing market in terms of whether it's a market for buyers or sellers. But the better question, especially for those looking for a new place to live and have the means to do either, is whether it's a buyer's market or a renter's market.
When the demand for housing overall is high and both rents and housing prices are going up, as they are now, it might be hard to think of it as a better time to rent. But right now, the increase in housing prices is eclipsing the rents in many places.
In the U.S., prices of single family homes increased by 24% while rents rose 5.4%. It's a similar picture in many cities too. For example, in Austin, housing prices jumped by 25% while rents increased 6.4%. In big metro areas like San Francisco and New York, housing prices have increased even as workers fled during the pandemic, while rents dropped significantly.
I am on leave at the University of California Santa Cruz, a luscious university hippie town, recently referred to as “Palo Alto by the sea.” Silicon Valley money coming from 30 miles away helped make house prices jump 26% in one year. The rental market is competitive, but still makes more financial sense when I apply a metric Nobel prize winning economist Bob Shiller uses: a price to earnings ratio.
According to Shiller, you're in an overheated housing market and should rent if the ratio between the price of the house and the profit you could make renting it is over 20.
Say the home or condo you want to buy is $700,000 and you can get a rental profit of $2,000 a month (you might charge $3,000 but expenses take a third), or $24,000 per year. $700,000 divided by $24,000 gets you 29. The 20 rule says rent.
The website Smart Asset lists the price to earnings ratio in different cities. More than one-third of 84 cities with populations over 250,000 have ratios above 20, meaning you'd do better to rent there than buy an overpriced house. Examples include Atlanta, Austin, Boston, Denver, Honolulu, Miami and Oakland. Not so much in places like Detroit and Fort Wayne, Indiana, where buying makes more sense according to the price to earnings ratio.
There are other things to consider too, such as your time horizon, when debating between renting and buying, assuming you're able to do both. It usually makes sense to rent if you're going to live somewhere for less than five years given the associated real estate costs with buying. Renting may also give you more job leverage because you could be perceived as more of a flight risk when negotiating a raise.
To those who say renting is throwing money away: Don't forget that homeowners pay interest to a bank. They're also on the hook for maintenance costs and property taxes -- money with no guaranteed return. And there are opportunity costs to the funds used for a down payment.
But from an economics point of view, renting may make more sense than buying for a while. The forces pushing up housing demand are overwhelming the forces pushing housing supply, and interest rates are likely to stay low.
For those in the luxury home market, renting may be even more attractive. Princeton University economists show higher income people kept their jobs and accumulated wealth amid the pandemic -- and many may be looking to buy bigger homes, resulting in even more competition and inflated home values at the top end. Homes between $800,000 and $1.5 million are most likely to attract bidding wars, according to Redfin.
Economists predict it'll take a few years for new construction to make the market more balanced. Until then, consider renting to avoid overpaying in a seller's market.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Teresa Ghilarducci is the Schwartz Professor of Economics at the New School for Social Research. She's the co-author of "Rescuing Retirement" and a member of the board of directors of the Economic Policy Institute.
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