A pall has settled over the U.S. housing market. The first-time home buyer's credit has dried up, and home prices are down 29 percent from their 2006 peak. On Dec. 9 the latest release of the Federal Reserve's Flow of Funds data shows the value of homeowner equity in the third quarter of this year at $6.4 trillion—52 percent lower than four years ago.
Judging by the learned consensus at holiday parties—where homeowners swap sorry tales of underwater mortgages and bleak sales—don't count on things getting better in months to come. Hanging over the market is an ominous combination of a weak economic recovery, near 10 percent unemployment rate, an inventory of 8 million or so distressed properties, and uncertainty over the legality of foreclosures by major mortgage loan servicers. Celia Chen of Moody's Analytics (MCO) expects the S&P/Case-Shiller home price index will drop 8 percent from the second quarter of 2010 to the third quarter of 2011. Morgan Stanley's (MS) housing analysts, led by Oliver Chang, figure home prices will decline somewhere from 6 percent to 11 percent before finding bottom.
But does that mean it's a bad idea to buy a home? I don't believe so, based on some dispassionate analysis. For the long-term homeowner (or patient investor), a home appears to be one of the better investments around, with minimal downside risk. "Housing is priced to earn its historic real rate of return of 0.5 percent to 1 percent and interest rates are low," says Morris Davis, professor of real estate and urban land economics at the University of Wisconsin-Madison. "Now may be a once-in-a-lifetime time to buy."
Think of the rental and ownership markets as competing for the household shelter dollar. Richard Green, director of the Lusk Center for Real Estate at the University of Southern California, says that equation clearly favors owning. Even more striking, Green says he's "hard-pressed to think of a time when owning on a cash-flow basis looks so reasonable relative to renting."
Take this back-of-the-envelope calculation: Green notes the median U.S. house price is $170,500. The most recent American Housing Survey data (2008) put the median rent at $808 a month and the CPI-Rent index has been essentially flat since then. The cash-flow cost of renting is $9,696 per year. On the homeownership side, Green assumes an interest rate on a 30-year fixed-rate mortgage is 4.5 percent and that the buyer makes a 20 percent down payment. He assumes the buyer could have made 10 percent on the downpayment if it was invested elsewhere, the so-called opportunity cost of capital. Property taxes are 1 percent of house value, marginal income tax rates (state and local) are 25 percent, maintenance costs are 1 percent per year, and amortized closing costs are another 1 percent per year. Taken altogether, the cash cost of owning is $12,162 per year. Looks like renting still beats owning, right?
Not really. The typical apartment is smaller than the typical house, 1,300 square feet for the median rental unit vs. 1,800 square feet for the median home. Thus, owning the median home is about 10 percent less per square foot than renting the median rental unit. "You need no home price appreciation to still be ahead financially with owning," he says. "Your after-tax, out-of-pocket cost of owning is less than the out-of-pocket cost of renting."
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