Revisiting rent vs buy

By Felix Salmon
April 21, 2010
David Leonhardt today revists the great rent vs buy debate -- something I was talking about on All Things Considered just this weekend. He's also updated the excellent NYT rent vs buy calculator, which he uses to agree with Dean Baker that the point at which it makes more sense to buy than to rent is probably closer to 15 than to 20, if you're looking at the ratio of house price to alternative annual rent.

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

David Leonhardt today revisits the great rent vs buy debate — something I was talking about on All Things Considered just this weekend. He’s also updated the excellent NYT rent vs buy calculator, which he uses to agree with Dean Baker that the point at which it makes more sense to buy than to rent is probably closer to 15 than to 20, if you’re looking at the ratio of house price to alternative annual rent.

This all makes sense to me — but at the same time I’d still be tread warily if I were buying a place right now. For one thing, it’s worth avoiding the housing market between now and the end of the month, as would-be home buyers scramble to sign a contract before the federal tax credit of up to $8,000 expires. That’s bound to push prices up a little at the margin, and there’s no point getting caught up in the frenzy. If you need the tax credit to justify buying a house, then you shouldn’t buy that house.

More generally, Leonhardt seems to assume we’ve had all that we’re going to get, when it comes to house-price corrections. Check out his assumptions in his blog entry:

Among other things, I assumed rents and house prices would both increase 2 percent a year — along with inflation — and a mortgage rate of 5.25 percent.

The mortgage rate is reasonable — indeed, it might even be lower than that right now, although it does seem to be bouncing around quite violently, for reasons I don’t understand. But if you plug in zero appreciation for both rents and house prices, then in Leonhardt’s example you never get into positive territory, and level off with a loss of more than $5,000 on the house.

It’s hard to imagine a world where rents and house prices never go up — but we might well be entering just such a world. I rehearsed many of the arguments a couple of weeks ago, and I shan’t repeat them here — interest rates are low and rising; the government is artificially propping up the market; prices need to continue to fall just to revert to their long-term mean. But when it comes to rent vs buy calculations, the point is that you can no longer safely assume that rents will always go up. They might not have risen as much as prices during the bubble, but they did outpace inflation, and it does make conceptual sense that if house prices aren’t rising then there’s no real reason for rents to do so either.

My feeling is that house prices are going to fall in real terms — that they won’t keep pace with inflation — for the best part of this decade. And in that environment, buying a house is really not that smart, especially given the opportunity costs associated with doing so. Leonhardt’s calculator puts those costs, for his hypothetical $384,000 house with a 20% down payment, at $3,830 a year — 5% of the down payment. But in reality the opportunity costs are much greater than just the return that you would get on that money if you invested it. Renting gives you much more agility and mobility than if you tie yourself down by buying a place which might be quite hard to sell in a pinch. And having $76,800 in cash can come in extremely handy in many circumstances. For one thing, if say you’re laid off, it can pay the rent for a months if not years; if you’ve already used that money for a down payment, then you can’t use it again to pay the mortgage on your house.

So while Leonhardt is right that in much of the country price-to-rent ratios have come down to their historical mean, that’s not necessarily a good reason to buy. It would be more accurate to say that one of the many good reasons not to buy has gone away.

47 comments

Comments are closed.