Felix Salmon

Manhattan’s rent-vs-buy divergence

By Felix Salmon
December 30, 2010

You might be surprised by this: it’s counterintuitive, and acts as useful corrective to people who simply assume, when they buy an apartment, that the alternative is ever-increasing rent payments.

The median monthly rent for all luxury units in Manhattan, defined as the top 10 percent of the market by price, declined 18 percent to $6,950 in the third quarter from a year earlier, according to New York-based Miller Samuel. The median luxury sale price rose 13 percent to $4.39 million.

It’s conceivable that both of these moves could be partially explained in terms of falling mortgage rates, which help support prices and which also allow landlords to make money with lower rents. But in general, falling interest rates don’t cause falling rents, they just cause higher profits for landlords who refinance.

The stated reason for the divergence is that owners — both individuals and developers — think that prices are too low, right now, and would rather rent out their apartments for the time being, waiting for a more auspicious time to sell. Which implies that even in Manhattan there’s a significant “shadow inventory” of apartments at the top of the market which aren’t officially on the market but which the owners would still like to sell.

In any case, it’s hard to argue with the main thesis of the story, that this is a really good time to rent rather than buy, at least at the high end of the Manhattan market:

The gap between the cost of buying a luxury apartment and the annual cost of renting is at its widest since the first quarter of 2009, when the median purchase price peaked at $6.6 million. Buying cost 53 times renting in the third quarter, compared with 38 times a year earlier and 58 times in March 2009.

This isn’t an apples-to-apples comparison: the apartments at the top end of the rental market are still smaller and less desirable than their counterparts at the top end of the sales market. So the buy-to-rent ratio isn’t 53. But it’s clearly rising. And it’s high:

In the Manhattan market overall, the cost of buying an apartment was 25 times more than the annual expense of renting in the third quarter, up from 24 times a year earlier…

A 7,700-square-foot duplex penthouse at 610 Park Ave., with five bedrooms, a “walk-in butler’s pantry” and a private terrace, is listed for sale at $25.8 million… The monthly cost of renting that same apartment is $75,000.

On the Upper West Side, a 4,300-square-foot “trophy penthouse” at the Grand Millennium, with “two massive terraces” and Hudson River views, is listed for sale at $15 million, according to StreetEasy… It could also be rented for $45,000 a month.

These two apartments have buy-to-rent ratios of 28.7 and 27.8, respectively; that’s very high. As David Leonhardt says,

A good rule of thumb is that you should often buy when the ratio is below 15 and rent when the ratio is above 20. If it’s between 15 and 20, lean toward renting — unless you find a home you really like and expect to stay there for many years.

To put this in perspective, the rent vs buy calculations I did on Nouriel Roubini’s new pad came out in favor of renting; the buy-to-rent ratio there was 18.3.

My suspicion is that the rental prices are a good indication of where a rational property market should clear, and that the sale prices are therefore overinflated. Why that way around? Because people have no idea what to buy, these days: nothing looks safe. Bonds, stocks, gold — all of it looks pretty bubblicious. And cash yields nothing, while carrying the risk of being eroded by future inflation.

So people overpay for housing, because it’s a consumer good as much as it is an investment: even if it falls in value, at least they still have a nice home. In times of chaos, that kind of investment is as good a hedge against tail events as any. Which might explain why there’s excess demand for it right now.

6 comments so far | RSS Comments RSS

Shawn Tully put together an interesting piece here:
http://finance.fortune.cnn.com/2010/12/3 0/dont-believe-the-rosy-forecasts/

He affirms the same point you make. Bonds, stocks, and commodities are all looking pretty expensive right now. Real estate is also trading above its long-term trend. If all that is expensive, what is cheap? What is going *down* in price (at least relative to the others)?

As best I can figure out, the only thing that ISN’T costing more on a daily basis is labor. American wages are flat or down over the last three years. And, of course, wages (indirectly) make up a larger part of the CPI than commodities, so the formal measures of inflation aren’t screaming in pain yet.

Posted by TFF | Report as abusive

I think the Manhattan real estate market is skewed by foreign high net worth investors.

Posted by Commentasauris | Report as abusive

Shiller has the cyclically adjusted sp500 P/E at 22.7 for the end of year. 2011 will probably see some more climb, but unless earnings grow a lot more, it will be fantasy finance. It is fascinating how quickly we got back to this point, but we’re in something of an equity trap. Do you really want to be buying bonds, short or long, right now? Even with diddly for inflation, money market money is eroding month to month. Given all that, real estate price escalation is only marginally irrational.

Posted by ARJTurgot2 | Report as abusive

I suspect that the high, Shiller PE, low bond yields, low Fed funds rate, and high commodity and gold (alternative currency, not commodity) prices indicate that this is nearly as good as it gets in the financial markets. Any sort of downturn could gain momentum into another crach, in which case we will likely see massive layoffs in the financial sector with many jobs taking a decade or more to return.

I suspect that this is NOT a good time to buy Manhattan real estate looking at a 5 to 10 year horizon.

Posted by ErnieD | Report as abusive

ErnieD, I repeat my question, “If everything is expensive, what is cheap?”

The previous bubbles were stoked by massive leverage. I’m not certain, but as best I can tell the current bubbles are inflated by “quantitative easing” funds. As long as that money stays in the system, the bubbles will remain inflated.

Am I missing something?

Won’t argue your conclusion, though. High-end Manhattan real estate could suffer in a variety of ways.

Posted by TFF | Report as abusive

Actually seems kind of intuitive to me. The only people making any money in the current economy are bankers and brokers and of course they all want to live in Manhattan. As the recession continues and forces other folks to liquidate it simply opens up spaces for the long line of suits wanting to escape Connecticut and Long Island.


Posted by MathieuBCN | Report as abusive

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