Rent vs. Buy Because of Many Factors

Rent vs. Buy

Because of many factors and costs to consider, the decision to rent vs. buy continues to plague the minds of many. A strategy for one person may not be a prudent strategy for another. Hence, the answer is rather relative as oppose to an absolute or universal decision. The real estate market is one of a cyclical nature, with periods of ebbs and flows. However, the key is stability and longevity to withstand downturns.

Whether to rent or buy is a question that looms in the minds of many. The answer simply depends upon the current market conditions and the needs of the consumers. Over the past decade, owning has been a financial success for most people, with prices rising almost in a straight line, with low, low interest rates feeding into the equation and with homeowners' equity subsequently bounding higher. Conversely, in certain markets such as New York, Baltimore, Raleigh, and San Antonio, the decision to rent is a prudent strategy in which the costs are more affordable. Housing prices are still out of reach for many in certain major metropolis. Additionally, factors and costs must be considered, such as return of investment, return on investment, interest rates, price to rent ratio, pros and cons of renting, pros and cons of buying, homeowner's insurance, rental insurance, neighborhood choices, and mortgage options. However, the most critical aspects that warrant primary evaluation are price-to-rent ratios and interest rates. These two aspects help facilitate the outcome of the remaining eight factors and costs aspects.

In the end, deciding whether to rent or buy a home has much to do with your own interests and personality. A strategy for one person may not be a prudent strategy for another. Hence, the answer is rather relative as oppose to an absolute or universal decision. The real estate market is one of a cyclical nature, with periods of ebbs and flows. It is a confusing time in the market. On one hand, mortgage rates are at record lows, and in many cities, home prices have plummeted. Conversely, home foreclosures continue to rise, and the economy remains weak. Whether you decide to rent or buy, each has many pros and cons to consider. Arends (2010) purports, "First, homeowners need to look first and hardest at present cash flow. The cult of homeownership made no sense. If renting is much cheaper than buying, think seriously about it. There is no such thing as a "safe" investment."

Analysis: Rent vs. Buy in Real Estate

While home ownership provides security, it may not give one the returns provided by certain other investments. With history as a guide, one can reasonably expect roughly 8% annual gains on your stock portfolio over the long-term (Smart Money, 2011). Generally, house prices have a direct correlation to the rate of inflation. Buying a house is not strictly a financial decision. This may sound simplistic, but one should find a neighborhood and a house that is desired. Moreover, exercising due diligence to check on the sales price trends of homes in that neighborhood, interest rates, and mortgage options are critical. Over the past decade, owning has been a financial success for most people, with prices rising almost in a straight line, with low, low interest rates feeding into the equation and with homeowners' equity subsequently bounding higher. Perhaps, this is just about as good as it gets and conditions are going to deteriorate at least somewhat, with prices likely to stabilize or retreat a little and with interest rates set to rise at least modestly. Hence, the decision to rent vs. buy continues to plague the minds of many.

Rent vs. Buy Defined

As the housing bubble inflated, the math increasingly favored renting. House prices went up and up while rents stayed relatively flat, meaning one could realized cost effective measures by choosing a lease over a deed. Now, with the housing market in a pulp, the tables are turning.

Undoubtedly, it is easy to toss around reasons as to why it is always better to be a homeowner (that mortgage-interest deduction) or it is always better to be a renter (no property taxes, and who wants to fix his own garbage disposal?). For example, if one decides to buy, it's in his or her best interest to put down at least 20% of the purchase price, to avoid private mortgage insurance (PMI). However, the more complicated truth is that at certain times, it makes more sense to be a renter or homeowner in which many factors need to be considered before making a prudent decision.

Factors or Costs

Many factors or costs must be considered to make the best decision with the information available, such as return of investment, return on investment, interest rates, price to rent ratio, pros and cons of renting, pros and cons of buying, homeowner's insurance, rental insurance, neighborhood choices, and mortgage options. With 10 aspects to consider, it is conceivable as to why the decision presents some challenges. However, the most critical aspects that warrant primary evaluation are price-to-rent ratios and interest rates. These two aspects help facilitate the outcome of the remaining eight factors and costs aspects.

Price-To-Rent Ratio

To figure out which is better now, start with the fact that in the long-run, the costs of owning and renting stay in fairly steady proportion. Economists call this the price-to-rent ratio -- take the average cost of buying a house and divide it by what one would pay in rent in a year. The analysis shop Economy.com calculates that since 1986, the price-to-rent ratio for U.S. cities has averaged 16.5. In other words, the price of a house is the same as what one would pay to rent it over 16.5 years.

In late 2001, this ratio began to climb, and by 2003, it was soaring along with home prices, hitting 24.7 in 2005. In those days, one could get 24.7 years in a rental for the cost of a house. However, since the end of 2005, the price-to-rent ratio has been falling, thanks to the home-price implosion. Across major U.S. cities, the ratio is back to 17.4, practically its historical average. A year ago, it was a better deal to rent. Now the market has a significant number of areas, especially those hit the hardest by the correction. Consequently, comparing prices to rents in a significant number of areas, one would be led to believe that it is an ideal time to buy.

At TIME's request, Economy.com ran the numbers for 54 metro areas and compared their current price-to-rent ratios to what their ratios have been over the past 15 years (NAR, 2011). In 21 cities, renting still looks to be the better bargain. Among the renter-friendly outposts are Baltimore; Raleigh and Charlotte, N.C.; Salt Lake City; San Antonio; Trenton, N.J.; Philadelphia; Honolulu; Seattle; and Portland, Ore. However, the other end of the spectrum exists in which cities where houses for sale look inexpensive compared with rentals. The top 10 metro areas on that list are Cleveland, Phoenix, Las Vegas, Cincinnati and, in California, Oakland, Riverside, Sacramento, San Francisco, Los Angeles and San Jose. An important caveat: those cities' 15-year price-to-rent ratios include the bubble years. Does Las Vegas appear cheap? Sure. The current ratio there is 14.6, significantly, below where it has been over the past 15 years (19.3) (NAR, 2011). However, that average has been influenced by the boom years.

The government mortgage agency Ginnie Mae has a rent vs. buy calculator on its website -- using the default settings, buying starts to make sense after committing to stay for at least four years, although a lot of assumptions go into that calculation: everything from the property-tax rate to mortgage closing costs to the money spent on homeowner's insurance to the yearly home-price appreciation. If prices stay flat instead of going up 2% a year, it will take nine years for buying to pay off.

Impact of Interest Rates

Which way are interest rates moving? Are they moving up or moving down? If interest rates are near an all-time low and beginning to inch upward, waiting could cost one more than he or she would think. A person might not be able to afford to buy a home at any price, thus affecting one's purchasing power. Below is an illustration of purchasing power:

Each 1/2-point increase in your interest rate gives you $25,000 less in purchasing power.

Each 1-point increase in your interest rate gives you $50,000 less in purchasing power.

Each 2-point increase in your interest rate gives you $100,000 less in purchasing power. (Weintraub, 2010)

Measurement

According to the New York Times (2011), "Whether renting is better than buying depends on many factors, particularly how fast prices and rents rise and how long you stay in your home." Such a decision may be based on longevity, such as if one plans to stay in the home beyond 6 years to realize a return on investment.

Ratios & Indices

Price-to-rent ratios measure the selling price of a typical house divided by a year's worth of rent. A ratio that is higher than average for that city tells us that renting is a good deal. A ratio that is lower than average indicates that maybe it is time to buy

Buying looks like a good deal in these cities & #8230;

Source: Moody's Economy.com analysis of data from the National Association of Realtors and Property and Portfolio Research

Effects of Interest Rates

Look at the Differences among Purchase Prices vs. Interest Rates

If you put down 20% and qualify for an 80% loan, here are your principal and interest payments on the following purchase prices (Weintraub, 2010):

$425,000 sales price, at 8.25% interest, your payment is $2,554.

$450,000 sales price, at 7.75% interest, your payment is $2,579.

$475,000 sales price, at 7.25% interest, your payment is $2,592.

$500,000 sales price, at 6.75% interest, your payment is $2,594.

$525,000 sales price, at 6.25% interest, your payment is $2,586.

The payments are almost identical. However, the home one can afford to buy at 8.25% is $100,000 less than the home that one can afford to buy at 6.25%. If a person waits for prices to further decline, the perceived value could be lost due to higher rates.

Analysis

Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply Represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship. When supply and demand are equal (i.e. when the supply function and demand function intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded (Investopedia, 2011).

When applied to real estate, the principle of supply and demand refers to the ability of people to pay for housing coupled with the relative scarcity of real estate. For any type of good or service to have value in any marketplace, it must possess four characteristics: demand, utility, transferability, and scarcity. Demand is a need or desire coupled with the purchasing power to fill it, whereas utility is the ability of a good or service to fill that need. Scarcity means there must be a short supply relative to demand.

Based on the below illustration, an over-supply means lower prices and an under-supply means higher prices. Hence, price is a reflection of supply and demand, thus affecting the decision to rent vs. buy.

Summation

Pros & Cons of Renting & Buying

Source: Home Buyer's Information Center, n.d.

Volatile home prices and subprime uncertainties cause people to delay house purchasing and rental costs to increase. Fewer homes are selling and rents are on the rise. It is a big change from just a few years ago, when home prices were appreciating like mad and everyone wanted to benefit. During the housing boom, the rent vs. buy decision became a buy. Now, nationally, the pendulum is swinging the other way. As a result, there are fewer vacancies and increased demand for apartments, allowing landlords to raise their fees. Tighter lending standards are also playing a part by locking more people out of home ownership and increasing competition for rentals.