But that's not what this post is about--it's actually about real-life finances. Lorna and I found a recent "Homes and Land" magazine that had a whole lot of "for sale or for rent" listings. We fired up a calculator, and figured out that most of these listings were priced at a 250-350 multiple (measured as purchase price / monthly rent).
Housingtracker.net has computed this ratio all over the country, and it puts LA around 315, a similar range. This is extremely high, as you might know. So it's cheap to rent, but how cheap is it?
Also, I admit there are some irrational reasons to buy that don't correspond exactly to simple division. But at some point these ratios have to make sense, right?
Let's do another calculation to see. There's a rent/buy ratio assuming you're renting from the bank. This is called an "interest-only" loan, and you can estimate it pretty easily on bankrate.com. It means you pay the interest rate exactly (no principal) every month.
Here are two simple cases, and our calculations are made all the easier by assuming an interest-only loan with no equity (I'm so 2006)--the payment is the interest rate. You may not agree with my estimate that housing will decline an additional 30% in some areas of LA, but you can adjust the 6% the other direction if you don't like it. (Transaction costs are somewhat undeniable, unless you use a discount broker like Redfin.)
1. Conforming Loan, 2008-2013, excluding transaction costs
- Interest rate: 6.375%
- Taxes + Insurance + Upkeep - Tax Deduction: 1.5%
- Rent/buy base multiple ("just pay my monthly costs"): 150x (2.1x cheaper to rent)
- 5-year depreciation (annual housing crash cost): 6%
- 5-year transaction fees (buy+sell over 5 years): 2%
- Rent/buy and sell in 5 years multiple: 75x (4.2x cheaper to rent)
- Base monthly payment: 126x (2.5x cheaper to rent)
- Full cost multiple: 68x (4.6x cheaper to rent)
So how did we get to 315? Well it's easy. The NY Times did a great Flash app that lets you compare the costs of renting vs. buying. If appreciation in prices are 5, 10, or maybe 20% annually, you shouldn't rent. If reality sets in...
My estimate is that Option ARMs in high-priced areas saved people nearly half the monthly payment (allowing prices to rise so far in comparison to incomes), and when one ignores transaction costs and expects 20% annual appreciation, then things start to look even better.
And all of this...will change soon.