Monday, April 11, 2005

To Buy or to Rent, That is the Question

Now might be the worst time ever to be a first-time homebuyer in the US. To me, the buy or rent dilemma isn't a dilemma at all. If possible, one absolutely must rent instead of buying a first home. Now if somebody has tons of cash, four kids, or lives in an area devoid of rental property - they may justifiably ante up for a house. But most people are not in that situation.

A couple of quick points. House prices are substantially higher than their derivative rental prices. This means that a mortgage on a two bedroom apartment is a lot higher than its market rental cost.

Here is the quick and dirty analysis that I use. Consider that every $100,000 of house costs about $600 a month in mortgage payments. So the two bedroom units in Brooklyn Heights that were listing for $550,000 cost about $3300 a month in mortgage payments. Yet these units can be rented for around $2000 a month. This renting discount is not unique to New York, it is a nationwide phenomena.

I must have heard a hundred times in the last few years, "Well I don't want to piss away money on rent..." So instead these people opt to piss away money on interest. If you mortgage $300,000 at 6%, you will end up pissing away $1500 or so a month in interest. And don't forget real estate taxes, maintenance, PMI, insurance, and the costs of possibly moving later on. Suzy Orman debunks the "tax break" myth and makes a few other relevant points in the link below.

suzy orman

I know that if you go the adjustable route, you can mortgage $100,000 worth of house for $390 a month. Absolutely do not do this, unless you have cash on hand with which you could pay off almost your entire mortgage amount should rates spike. Rates are just off of 46 year lows - lock in a fixed rate and if they go lower, you can always refinance. For you ARM gamblers, don't forget that rates went above 15% in the early 1980s. Most people couldn't handle a move to 9%.

Suffice to say, I am bearish on the real estate market. Here are my reasons:

There are too many people buying today with adjustable-rate products and interest-only loans. Incomes are lower, particularly among young people, than they were 5-6 years ago. The Federal Reserve seems determined to prick the housing bubble. Inflation is taking root and has historically been anathema to interest rates. Half of new construction in Florida is estimated to be "investment" properties. Last year in California, half of new mortgages were "interest only". For more on the stupidity in the land of fruits and nuts, click on this link, it is unbelievable.

Anecdotally, I have come to the same conclusion. I know several people who have bought homes the last few years that have appreciated immensely - at least on paper. Almost without fail, each one of them has either taken out a home equity loan, built an addition, remodeled the kitchen, bought another piece of property, or moved into a bigger home with an increased mortgage. Rare is the story of a homeowner selling his house and downsizing to a smaller home, cheaper region, or RENTING. Here is the bull market analogy - did anyone actually dump their AOL/Time Warner stock when it was over $100 (currently $18 per share)?

In summary, I believe that incipient inflation along with coincident rising rates, will couple with super-leveraged buyers to create the perfect storm for real estate. I am predicting some serious economic pain within 2-3 years. Remember, a pendulum swings both ways.

(I am still shaking my head at that LA Times article.)

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