Rent ratios, affordability and cap rates are saying housing is a buy

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This post is a guest contribution by Paul Kasriel* of The Northern Trust  Company

In today’s (April 21) NYT, David Leonhardt writes that rent ratios – the market price of a house divided by the annual rent of a comparable house – are suggesting that in many regions of the country, the purchase of a house makes more economic sense than renting a comparable house (In Sour Home Market, Buying Often Beats Renting).  According to Leonhardt, when the rent ratio is above 20, renting makes more economic sense. When the rent ratio is below 20, a home purchase makes more economic sense. “In many large metropolitan areas, including New York, Los Angeles, Chicago, Houston, Dallas, Atlanta and South Florida, the average ratio is now 16 or lower. It was more than 25 in several of these places at the peak of the bubble, about five years ago.”

The National Association of Realtors calculates a Housing Affordability Index (HAI). This index is a function of the level of mortgage rates and the ratio of house prices to household income. The lower the level of mortgage rates and the lower the house price-income ratio, the more affordable is a home purchase (i.e., the higher is the value of the HAI).  The HAI index =100 when median family income qualifies for an 80% mortgage on a median priced existing single-family home. A rising index indicates more buyers can afford to enter market. Chart 1 shows the history of the HAI from January 1971 through February 2010. The highest reading for the HAI was 184 in January 2009. The February 2010 reading was 176. The HAI is sending a signal similar to the Leonhardt’s rent ratio – owner-occupied housing is a buy.

Now, before running out to buy a house, take a few things into consideration. Firstly, housing could become even “cheaper” if house prices resume their decline as foreclosed houses come on to the market. Secondly, rents, either actual rents on rental houses or imputed rents on owner-occupied houses, could fall. But all in, a house purchase today looks pretty attractive, financially speaking, especially if the contract is signed before April 30.

Source: Northern Trust – Daily Global Commentary, April 21, 2010.

* Paul Kasriel is Senior Vice President and Director of Economic Research at The Northern Trust  Company.

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1 comment to Rent ratios, affordability and cap rates are saying housing is a buy

  • John Hanson

    Houses are still not affordable. Interest rates have been artificially low for more than a decade and this helped increase home prices. Add to this fact that most people’s income (except for government workers) have not kept up with the rate of inflation in home prices over the years and I don’t see how anyone can say now is the time to buy a home.

    The government has bailed out home owners over the last couple of years, trying to put a floor under the falling prices. They will eventually run out of other peoples money and then maybe home prices can reach their equilibrium or market clearing price. My guess is that home prices need to fall another 20%.

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