It is true that rents have not kept up with purchase prices.

The old rule of thumbs, like monthly rent being 1% of purchase price, no longer apply in today's market.

Low interest rates (and stupid credit terms to let unquilified people qualify) have turned lots of renters into home owners. That has affected vacancy rates, which prevents rent rates from rising.

What kind of house can you rent for $875?

I'm getting $1600 for a small two bed one bath one block from the ocean built somewhere in the 20's or 30's.

You're forgetting the equity that you are getting and it's growth. In addition, although you may believe that home prices are going to depreciate over the next 5 years, the long-term says that is not the case. If depreciation does happen, I'd suspect it would be the $1mil homes that are 1400 sq ft on tiny lots in the heart of undesirable suburbs. Don't forget there is a huge net influx of folks to Kali, some ridiculous number like 400K/yr.

Wayne,
Keep reading to the last line. Pop is still increasing. Not all the immigrants are from poor countries, and even the poorer people are buying homes because of the crazy loan practices that the loan companies are pursuing. I don't know about the Kali real estate market for sure, but I doubt whether things are headed down. They may be flat for a while, but unless alot of these loans start defaulting that is not going to happen. Maybe continued fuel price increase and jobs going to China will do it, but I don't think that anyone can reliably predict what will happen.

I've looked at a number of markets over there, and although no one is seeing 20%/yr, prices cont to steadily increase. In Fl, I thought that the market might get depressed with the rate increase, and it was slow for a while, but apparently the median price is up by 100K in the city I live in, and showings are back up to 1 yr ago's levels.

I wish that prices would go down too, just doesn't look like that will happen. Seems to me this is like $3.50/gal gas, no real rhyme or reason to it (other than too much money to invest and the whole "futures" market), but it's there and not apparently going to go away.:confused:

Just exactly what state are you planning to buy in where the property taxes are only .0033% ?
Where I live, you should plan on paying closer to $340 a month in property taxes on a $350,000 home.
And while I agree the immigrants are replacing the people who are fleeing Mexifornia (I've heard it refered to as brown flight) the immigrants are buying homes. They do it by putting up to 10 families in one house.
It doesn't happen yet in million dollar neighborhoods but I have seen in in $700,000 homes. Not exactly the kind of thing you want next door.

In Orange county you can rent for $850 a month, assuming you are comfortable with a one bedroom loft style apartment in a less than desirable neighborhood (and no garage). I know that for a fact, because I used to own and rent out a one bedroom condo that I sold 7 years ago. I was getting $850 a month rent for it, back then!
For a 3 bedroom condo or house in a decent area, plan on paying 3 times that amount in rent or more.

One more thing to put into your equasion:
if you buy a home, the mortgage will stay the same unless you are dumb enough to get into creative financing or adjutable rate loans when the rates are climbing. That means than it 5 or 10 years, it will be easier to swing the payments. In 15 years the payments will look small.

If you rent, the rent will keep going up. And up. And Up.

The longer you live in a home you bought, the more affordable it will get. The longer you rent, the less affordable it will get.
And all of that is with not even bringing appreciation into the picture.

One other thing to consider: the average joe that rents is not as desirable as a neighbor as the average person who owns his own house. I said average, I know there are exceptions.
I personally don't want to live in a confined area with a bunch of renters. Parking problems, noise, parties, who needs that next door?

For most, it all comes down to either renting a house, or renting money to "buy" a house.

If I lived in CA, I would definately follow Waynes lead. Up here, in the PNW, holding on to property seems the smart thing to do.

opportunity cost = ?

Dave Ramsey says he loves rental property, but unless the deal is putting money INTO your pocket every month it is a risk he will not take. I respect his opinion. There is a risk of housing price drops, deadbeat renters that live there for 6 months while you go through the eviction process(maybe less likely with a nicer home?) and the possibility of having it be vacant.

His site is www.daveramsey.com if you want to check it out.

The guy that wrote "Rich Dad, Poor Dad" had a similar opinion. If it takes money out of your pocket every month it is a liability. If it puts money into your pocket every month it is an investment.

Just another data point and opinion for you.

The foreclosure rate is already trending upward.

Many marginally qualified people took out interest only ARMs to buy their dream house two or three years ago. Now that interest rates have gone up significantly, lots of these people are struggling.

I don't forsee massive drops in RE values, but just as higher vacancy rates for rentals keeps rent from rising, having more houses back on the market will stop the silly growth of RE values we've seen lately.

Would the money in the bank get the same leveraged returns of homeownership? Assuming no market correction downwards, your money in the CD gets around 5.6% (whatever you cited), but in the house, you get 2:1 leverage on a 50% downpayment. So if housing appreciated at the same 5.6% annually, then you get closer to 12% return on your investment. All though no guarantee on the housing market. So the question is what do you think the housing market will do in the next 5-15 years in LA?

Also, I don't think you considered that if you put the $175K into the house, the appreciation of that money in terms of increased value of the house isn't taxable and when you sell, you (I think) get a one time tax exclusion, but with the same money in a CD the interest you receive is treated as income and taxable by the State and Feds every year as ordinary income. SmileWavy

Miami is well....Miami. Don't live there and wouldn't want to. They saw gains alot like SoCal because everyone "had to be there". Wouldn't surprise me if they did take a hit. My area is more single fam homes, older folks coming to retire on the beach, and the prices cont to climb. The housing boom really has been driven by baby boomers, retiring and/or money to invest etc. I think that until the boomers start to decrease in numbers (significantly) there will be an inadequate number of housing units. That will take a while, maybe 15 yrs. And by then who knows whether the pop of the country will be growing. Furthermore, people continue to look at homes in a different light than a pure investment. Just my .02.

Wayne, your numbers look good. On the buy scenario, you should add principal paydown as a benefit.

Take the 5% of your $175k and buy put options on XHB, homebuilder ETF. It should tank by December 06. When the next quarter's put options are available (Mar 07), use another 5%. It's risky, but I have faith the homebuilders will be crying by then. If you lose, you're out $17500, but if you win, you win huge.

Wayne, my 2c:

You need to specify an investment horizon - how many years.

Include transaction costs to buy and sell the house. Commission, fees, title ins, etc. These are very material , especially with a shorter investment horizon.

You need to make some assumption on appreciation, otherwise you're leaving out a major part of the economics. Here's one approach to appreciation - chart your region's house price vs time, draw a long-term trendline (>30 years) through the data, assume that the house price will return to that trendline by the end of your investment horizon. Currently, that means for an investment horizon of several years, the house price will depreciate; for a longer investment horizon, the house price will appreciate. Quarterly data by metro area available as Excel download from the OFHEO website.

The AMT issue should be answered. If AMT reduces the tax benefit of owning a house, that changes the economics.

P.S. I did a long post, > 1 yr ago, re OFHEO data for CA. Find via search. Had link to site + LT growth rate for CA house px. LTG was =< S&P500.

If you compare appreciation rates to equities, you can't ignore the influence of leverage.

The .75% increase in 30 yr rates over the past 12 months equates to an 8% increase in monthly payments. So, for 2006, I predict a 3-5% fall in nationwide housing prices. A year-over-year decline in nationwide prices is unprecedented, but all signs are negative at this point.

The presage is rising inventory levels, huge incentives by national home builders, and accelerating default levels.

Wayne, I'd like you to consider one factor that does not always show up on a spreadsheet -- we didn't buy a home purely for financial reasons - you also buy a home because it's where you want to live and how you want to live.

If you want to focus only on the short term RE concern, then yes, buying now and selling in three years carries risk. But buying now and selling in 20 years IMHO carries negligible risk. In that span of time, you have leverage working to your benefit. The 20% down ($70K) is controlling a $350K investment. We can debate historical risk-adjusted returns till the cows come home. And I'm sure you know that market timers typically do not show investment returns of steady investors - this applies to stocks and real estate.

Back to the emotional reasons for home ownership. It's your home, not someone else's property. That means as long as you make the payments, you get to live there. That's not true of rent. Leases end. Rental properties are sold. Families generally desire the continuity and stability of living in a community, in a neighborhood. If the lease is not renewed, you have risk of changing schools, different neighbors, etc. While you can paint walls and change carpets, you won't make the kind of semi-permanent infrastructure improvements on a rental home. Like nice garage cabinets, 220V for your welder, built-in bookcases for your living room. In other words, whenever you think of improving your surroundings, you are confronted with the fact that it's not your home.

When we relocated to Northern California two years ago, I wanted to rent a house because I was concerned about the real estate market and thought there might be short term job risk. But in the relocation, my family needed the stability that only home ownership can provide. That benefit was priceless. (And the 45% odd increase in property value does not hurt either)

So I think your math should include a time horizon to show the true net effects (appreciation or depreciation, etc.) plus a valuation factor for the personal benefit of home ownership. Call it factor X and let each assign their own "peace of mind" value. For some, it might be $100 per month, for others, it might be $10,000. It is for me.

Valid point. Most homes aren't investments. Today's environment has conditioned folks to believe that most investments should be homes, or worse yet, a home as one's only investment.

If you're looking for protection against depreciation, you might want to investigate the new housing futures from Chicago Board of Trade, I think. If your region appeciates, you've covered. If your region goes down, you have a hedge.

I had a few minutes so I threw together this spreadsheet - rent_v_buy.xls.

It allows you to specify a time horizon, interest rates, rates of appreciation, etc.

I've not thoroughly audited the sheet, so caveat emptor. But if you find any mistakes or want to question my assumptions, please let me know!

Don

Wayne - the sheet I posted (updated 1 min ago) accounts for principle reduction when the house is sold, and in the rental scenario, assumes your rate of interest increasing the down payment as you did in your presentation.

True, true. Equity does not put food on the table, but it can help one sleep at night. Regardless, the numbers you present for CA housing are insane. I would have cashed out a long time ago. I could never stomach a return of less than 3%. After expenses, the rate likely drops to 2%. The only thing that can save this housing bubble is hyperinflation.

So I updated the sheet with a tab that has a "net worth" end result instead of selling the property. The big variable is your bet - what is appreciation going to be? If you pick 0% over 5 years (correction and return to today), then yes, there's a swing of 65K in the model.