The Housing Chronicles Blog: How do you know when the time is right to buy a home?

Monday, August 4, 2008

How do you know when the time is right to buy a home?

L.A. Times reporter Peter Hong has written a story on how to gauge whether or not it's the right time to jump back into the housing market. Although there have been stories elsewhere on the web about this subject, what I like about this article is that he discusses how to value homes like a stock -- in other words, the dividend that one can get from renting it out or the savings from not choosing buying over renting. This is a crucial calculation that everyone should make when buying a home, and he also interviews Drs. Gary and Margaret Smith, authors of the book "Houseonomics," which I'm reviewing for the Times:

Southern California median home sale prices are down about 30% from their peak. That's about as far as they fell in the 1990s real estate downturn, and enough of a decline to have many asking: Is it time to buy?...

More than half of the adults in the Los Angeles metropolitan area own their homes. But because of the price run-up that began in the late 1990s, fewer than 11% of adults in the L.A. area earn enough to buy a median-priced home of $412,000, according to a National Assn. of Home Builders index.

As recently as 2001, when the median was lower, that figure was about 38%.

Los Angeles economist Christopher Thornberg believes that home prices will stabilize when homes are affordable to about 25% of the adult population. For that to happen in Southern California, home prices would have to come down 20% to 35% from their current levels, Thornberg said...

Home prices are also relatively high compared with rents. The ratio of home prices to annual rents in the Los Angeles area was 20 as of March 31, meaning the median home sale price was 20 times a year's rent for a comparable property, according to Moody's

The 15-year average ratio in Los Angeles is 16.4.

It's true that rent checks don't generate returns. But renters can take the money they would have spent on a down payment and invest it in stocks, mutual funds or other investments (20% down on the median-priced Los Angeles home would be about $82,000) and are spared the costs of home maintenance and repairs...

Margaret Smith, a Claremont financial planner and former university economist, takes it a step further, saying that a home is almost always a smart investment, even if values do temporarily decline.

Smith and her husband, Gary Smith, a Pomona College economist, say buying is practically a sure bet when you would pay less for a monthly mortgage and other home costs than what it would cost to rent the home.

They call that monthly savings the "home dividend" and say it will offset a short-term decline in a home's value. The monthly rent savings not only is money in your pocket but also can be invested elsewhere.

Even if your mortgage payment and expenses start out higher than comparable rent, the payment becomes relatively cheaper as rents increase -- provided it is a fixed-rate loan. "You can certainly turn a negative into a positive over time," Margaret Smith said.

In addition, mortgage interest and property taxes can be deducted from income taxes, potentially shaving thousands off annual home costs.

By Smith's formula, the home dividend for someone who buys a $355,000 home (the Southern California median) would be nearly $1,000 after one year compared with renting a home for $2,000 a month.

That is, the buyer -- even with the added expenses of homeownership -- would spend less on his or her housing costs than rent because of mortgage interest deductions.

"Stop fixating on short-term price moves; think about long-term rent savings," Gary Smith said.

If someone delays buying a house that would produce rent savings to hold out for a better price, the delay would mean losing those savings -- and the loss could be compounded if prices went up instead.

"Buying a house is risky, but waiting is risky too," Gary Smith said.

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