Consumer Comeback Blog

Buying vs. Renting in the current recession

In a recession caused (in large part) by the bursting of a housing bubble, many people are left wondering: is right now a good time to buy a home or does it make more sense to rent? A recent article by the Wall Street Journal reported that 1/3 of metro housing markets in a Zillo study showed a price-to-income ratio level that suggested homes are being undervalued.  See the video below:

 “For decades, price-to-income levels have moved in tandem, with a specific housing market’s prices rising or falling in line with local residents’ incomes. Many economists say that makes the price-to-income ratio a good gauge for determining whether housing is undervalued or overvalued for a given market.

Zillow found property prices in one-third of nearly 130 housing markets across the nation were undervalued, when compared with residents’ current income and the pre-bubble trend.”

Couple undervalued properties with historic low interest rates and it certainly may seem like right now could be the perfect time to purchase a house. But the truth is, there are a number of factors and considerations that suggest this may not necessarily be the case:

Beware of the “rent-to-buy ratio” in a recession

One of the major financial considerations potential home buyers account for in their decision of whether or not to purchase a home is the rent-to-buy ratio. It’s a simple formula:

(purchasing price of a home)/(the annual rent of an equivalent space)

It’s suggested that if the ratio is anywhere below 15, it makes more financial sense to buy; If it’s above 18, however, it makes more financial sense to rent. And for those who really want to take it a step further, you can use more complicated calculators that take other factors into consideration.

But even if this isn’t necessarily the best (or only) means to justify a house purchase, in the current recession, RTB ratios can be downright deceiving. There are a few factors keeping this ratio relatively low at the moment: stricter credit restrictions and high down payment requirements make it harder to get a mortgage, questionable job markets and the desire for mobility favors renting, and the general fear of buying a deflating asset. So not only will these factors benefit the renting market, but they will also continue to contribute to the weakened state of a real estate market until these some of these factors turn around and/or house prices reach their low point. Which brings me to my next point:

Real estate markets may not have hit a low point yet

There is plenty evidence to suggest that declining real estate markets haven’t yet begun to normalize let alone recover: foreclosures are on the rise again and home prices continue their downward trend. In fact there’s not much to suggest that these trends will change any time soon. Despite the WSJ’s optimism, 2/3 of housing markets are still considered over-valued with the overall national average 14% above pre-bubble numbers. This suggests that there is still more room for housing prices to continue to fall meaning the perfect time to “buy low” may not be here just yet.

Real estate recovery will be slow

Recovery will be slow nationwide, but perhaps more importantly, markets that are hurting the most may take the longest to recover. Historically, real estate recessions take a long time to recoverand with the wide-spread severity of our current recession, it’s fair to assume some areas will be in this for the long haul.

Those waiting for the right time to buy a home should be fully aware of this fact. Buying low may be the first rule to investing, but it only makes sense when there is reasonable expectations of growth. So when potential home buyers are considering the financial benefits of purchasing a house, in terms of home value, both initial price and expected growth are important. So unfortunately, in markets where the prices are at their lowest, the expectation for growth may be as well (see: Detroit).

Not all housing markets are the same

Beyond a doubt the most important factor in considering a home purchase is analyzing the market in which you are buying. National based numbers certainly can’t do that and it’s worth noting that not all housing markets have been or will be effected by the current recession. Washington D.C. is a great example of a housing market that continues to boom despite the current recession.

But even markets that have not yet been touched by the current economic crisis may be risky real estate ventures. Instead of comparing the local market to national averages, look at the trends for the individual market. Watch out for quick spikes in home value prices when compared with local income rates. Healthy markets have slow and steady growth along with a relatively steady growth in income.

Pay close attention to local job markets

One of the most important factors when determining the future health of a real estate market is the current and future viability of the local job market. High unemployment rates and low (or declining) median salaries are two troubling signs that the local housing market is or will be on the decline.

In our current recession, unemployment is as big a problem as it’s been since the great depression, particularly in the areas that have been hit the hardest. This is one of the reasons that these areas will take longer than the rest to recover.  So when considering a house purchase, particularly in an area hit hard by the economy, it may be best to wait until local unemployment rates begin to return first.