Wednesday, May 28, 2008

Buy vs Rent.

H/T to Talus for the link via Mohican.

From the NYTimes: (in bits and bites)

One of the big lies of the real estate business is the idea that renting a home is tantamount to throwing money away. It’s a useful fiction for real estate agents, because they make vastly bigger commissions on house sales than rentals. But the comparison isn’t nearly so straightforward for the rest of us.

Renting involves one obvious, recurring cost that can never be recouped: the monthly rent check. Buying, on the other hand, involves multiple expenses, some of which aren’t so obvious. On top of closing costs, there are repairs, property taxes, mortgage principal and mortgage interest...When you own, you also lose the ability to invest your down payment elsewhere, like the stock market.

Over the last several years, I’ve come to like a simple, back-of-the-envelope way to compare the costs of renting and owning. You find two similar houses, one for sale and the other for rent, and divide the sale price by the annual rent. You can call the result the rent ratio.

The concept will probably sound familiar to stock market investors. It’s the real estate market’s version of a price-earnings ratio — a measure of how expensive an asset is, relative to the underlying economic fundamentals. Like a P/E ratio, the rent ratio provides something of a reality check.

You should really read the rest. It's US specific data, but the same underlying factors apply here and the ratios are fairly similar. A good read, thanks Talus.

They even provide a cool Buy vs Rent calculator to play with.

A welcome addition to the Victoria RE blogosphere has arrived. Womp brings us MLSstats.ca for daily stats on the local market, emulating one Realtor I'd happily work with in Vancouver, Paul.

UPDATE: a week ago I gave you some snapshots of low-end market inactivity. A week later, of the 16 May listings for SFH in my criteria four have sold:

MLS #246067 original price $419,900. 16 days on the market. Sold for $390,000 or 8% less.

MLS #246160 original ask $419,900. 8 days on the market. Sold for $425,000. (It's a triplex).

MLS #246156 original ask $399,900, sold after 10 days for $375,000, a full 7% less.

MLS #246107 original ask $389,900, sold after 11 days for $377,500.

41 comments:

patriotz said...

A buy versus rent calculator should not make any assumption about price appreciation. The reason is that price is not an independent variable, but must adjust to rent in the long run.

Instead the calculator should assume the house is owned forever and should compare the price to the present discounted value of an infinite number of rental payments.

This is not the same as assuming zero appreciation for the house.

Billy TwoBaulz said...

FWIW, my current rent ratio is 39 - on my new place I'm moving to this week, it's at least 66.

talus said...

My rent ratio is 31.25

(based on BC Assessments disclosure of the sale price of this rental)

To reach a rent ratio of 20 this place would have to drop $260K or about 35%..... sounds reasonable to me.

talus said...

Instead the calculator should assume the house is owned forever and should compare the price to the present discounted value of an infinite number of rental payments.

I really want to understand this can you explain further please?

Anonymous said...

This would mean that you would have to capitalize the net income stream at a market determined rate after allowing for vacancy and bad debt. The difficulty is to determine the property specific captilaization rate from the marketplace. A rate that would vary depending on the risk associated with that property. You could also do the calculation using the Band of Investment method given the you know how to calculate the Internal Rate of Return.

Some how I don't see Bob the clerk at Mac's doing this.

KISS priciple ("K"eep "I"t "S"imple "S"tupid")

Siobhan

hhv said...

Talus,

can you break down how you calculated your multiples please?

I've not been doing the calcs correctly, I'd like to see where I'm off.

Cheers,

Anonymous said...

The plummet begins?:

503 - 760 Johnson (The Juliet) listed for $459K in Sept 07, sold on May 23, 2008 for $390K. 15% below the original asking price.

- awum

patriotz said...

Some how I don't see Bob the clerk at Mac's doing this.

We are talking about online calculators.

It's actually simpler to do the calculation, and simpler for the user, when no assumed capital gain (or loss) is input.

talus said...

Here is my math...

House Price ÷ Ann Rent = "rent ratio"

Owners paid: $720,000
Monthly rent: $1920
Ann rent = 1920 x 12 = $23040

Therefore...

$720,000 ÷ $23040 = 31.25

To get back to the NY Times article rent ratio of 20 which the author feels is the upper limit (with the "norm" from the 70's thru 90's being 10 to 14)...

House Price ÷ Ann Rent = 20

X ÷ 23040 = 20

X = $460,800


In the case of my rental this represents a reduction of approx $260,000 or 35% from what the owners paid ($720,000 minus 35%).

Now, would I buy this house for $460,000 instead of rent it?? Possibly since I feel there is a small premium to pay for ownership BUT personally I feel that financially the payments would be difficult - and the premium still isn't worth it.

However, take that down to a "rent ratio" of 15 (still a premium but "it is Victoria after all") and you get...

House Price ÷ Ann Rent = 15
X ÷ 23040 = 15
X = $345,600

... a 52% reduction!

NOW YOUR TALKING!!

If anything I think the NY Times article supports the bubble assertion and that we are looking at a 35% to 50% reduction to get back to norms.

Either that or we all need massive wage increases (unsupportable) or massive rent increases (unsupportable)... correct me if I wrong but that would equal massive inflation??

hhv said...

Thanks Talus,

I'm not sure if you can arbitrarily apply the 20 rule to the Victoria market. Doesn't that require an averaging of traditional rent to price ratios over say the last 25-30 years to figure out what our "20" should be?

greg said...

hhv -

you could look at the usual price/median earnings ratio for the same time period, and see what rent multiple is comparable based on that relationship.

For example, if price/earnings is something like 5 for most of the period (eg $350,000/$70,000=5), then for the period you could look at something like 14-15 as a usual multiple in the area.

$350,000/$24,000 ($2,000/month)= 14.5.

I think if you go back to the 70s, the comparable price/earnings would be even lower... for example a ratio of 3 would look like this:

$210,000/$24,000 ($2,000/month) = 8.75

Nice ratio back in the 70s, mind you, rents would have been lower.....

hhv said...

In 1992 a two-bed condo average price was $140K. A two-bed rental went for $684/month average. So using the calculations we get a rent multiplier of 17. 1992 was two years before the peak at 1994.

In 2007 (the last year data is available) a two-bed condo average was $320K. A two-bed rental went for $907/month. So using the calculations we get a rental multiplier of 29. We can make a case for 1997 being roughly 1-2 years before our current peak (if today doesn’t turn out to be that day).

The mid-point I would argue probably happened in 1998 or 1999 and those years the rent multipliers were 17 and 16. At the true bottom of the last correction in 2002, the ratio was 14.4.

If we accept these calculations, only for condos mind you, then it really puts this current price appreciation into perspective and demonstrates just how out of whack things are right now in Victoria. It would also explain why the 1994 correction was basically a “soft-landing,” because it didn’t happen due to construction glut and was more a case of economic factors in the province. It really shows that condo prices in this town could be poised for an especially hard time.

We also need to build in some leeway for what a two-bed condo is, compared to a two-bed apartment—which is what CMHC has the ability to track. The answer to this question lies in how much the market is willing to pay to rent a two-bed condo versus the apartment. I would guesstimate it to be around a 15-25% premium in any given location. So instead of $907/month in 2007, I think it would be closer to $1050-$1100, although I looked at two-bed condos in early 2007 for under $1K/month in my rental search in the same neighbourhoods as two-bed apartments renting for slightly less.

Anonymous said...

Here is my gross rent multiple

Market Value - $425,000
Economic Rent - $ 16,800

GRM= 25.3

In 1998 (pre-boom) when I started renting the home the numbers were:

Market Value - $185,000
Economic Rent $ 13,140

GRM= 14


Now, on to the future after the correction. Assuming the rent does not go down and the GRM returns to 14

$16,800 x 14 = $235,200

which is a correction in values by 45 percent. Property values would have to roll back three years to 2004 or 2005 price levels.

Yup, sounds reasonable to me.


Siobhan

Anonymous said...

OMFG a house sold today. I saw a sold sign on the house I ride by everyday. It's been for sale for months and some fool bought it. Two more for sale signs went up on the street last week to replace it though.

talus said...

I'm not sure if you can arbitrarily apply the 20 rule to the Victoria market.

I didn't mean it to be fact, just a "back of the envelope" WAG. I agree, we need more data.

Those "rent ratio" numbers came from an American source which I felt would be roughly equivalent to our market (but I could be way wrong). I don't know the what the full effect of the US ability to write off mortgage interest does to their pricing, let alone the source of the authors numbers.

My gut feeling (and the number Siobhan, greg, and yourself (hhtv) put up), tells me that Canadian numbers can't be too far off from their US counterparts.

Of course, Victoria could be different. But I don't think any of us bears are ready to bet on that yet.

-- Sell on hope, Buy on despair, and take the other side of emotional disconnects.

patriotz said...

Since the great RE bubble of the early 80's, RE in Vancouver and Victoria has been rationally priced only at market bottoms - i.e. around 1985 and 2000 or so.

It was at these times you got the rent ratio that had previously been the norm all the way since the end of WWII. It was a lot lower before that BTW.

And this is the norm we are going to return to after all the irrationality has been beaten out by Mr. Market. There are just too many negative factors converging on RE as an investment. Its time in the sun is over.

Anonymous said...

You can not "TIME" the real estate or any other market..Buy if you need one..

hhv said...

You can not "TIME" the real estate or any other market..Buy if you need one...

I'm guessing this guy has plenty of time for viral marketing...

and I'm pretty sure that you can "time" to a certain extent

Aleks said...

If there is any market you can time, it's real estate. Miss the bottom by a few months or even years and you're still fine.

Anonymous said...

I don't think Raj looks old enough to remember the last big real estate bust in BC, hence his timing comment above. Unfortunately for him Abbotsford will likely be hit very hard in the next few years. The smart money is out, just the suckers are left.

Anonymous said...

If there is any market you can time, it's real estate.

+1

Polar ice caps melt faster than real estate moves.

Wait a minute -- polar ice cap melting is bad.

beagle said...

Anon: May 30, 2008 12:14 PM

It's too bad you say that the market can't be timed because in the first paragraph of your site you state:

"In today’s very active and competitive Abbotsford real estate market, timing is everything."

B2B said...

Hey thanks to the anonymous genius above! Abbottsford certainly is the next Paris...I'm having second thoughts now and might go buy a house in Abbottsford.

Geez - "buy if you need one"! It's so obvious, I don't know why I didn't see it.

Fartcapitaloftheworld said...

Everybody wants to live/move/retire in Abbuttsfart! Victoria is just too far for the rich Calgarians to drive to.

vg said...

First GDP contraction in 5 years with another quarter projected has all the Canadian economists calling for a recession. Now who woulda thunk eh ? But Flaherty's in denial, whats new, we are well used to that living in La La Land.



OTTAWA — Canada's economy contracted in the first quarter of the year, the first time in five years that the country's output shrank outright, raising the spectre of a recession. But Finance Minister Jim Flaherty quickly dismissed such fears.

Real gross domestic product declined a harsh 0.3 per cent at an annualized rate, Statistics Canada said Friday, exposing an economy far weaker than economists' projections of 0.5 per cent growth in the first three months of the year.

“This is a bitterly disappointing and surprising result,” Dale Orr, chief economist for forecasting firm Global Insight Canada, said in a note to clients.

Anonymous said...

"suprising result"

More proof that economists are clueless at predicting anything other than "more of the same".

vg said...

agreed, how many times have we heard the past 6 months that Canada has decoupled from the US and that there isn't a snowballs chance in hell of a recession here nor a US one effecting us even in the slightest... utter crap.

Village said...

Abbotsford, that's funny. I spent a good portion of my life growing up there. When the only real attraction was Seven Oaks mall. That town has nothing attractive going for it other then it's not as bad as Chilliwack.

Alright, to be fair I have good memories of my elementary school.

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patriotz said...

and I'm pretty sure that you can "time" to a certain extent

It's not about timing the market, it's about pricing the market.

RE cycles always have flat bottoms. In addition, prices always fall toward rent equivalence at market bottoms, because that's what it takes to get investors back in.

Was true in 1985, was true in 2001, and will be true at the next bottom.

Buy a house at the right price and don't worry about timing. You won't be far off.

Toronto is Special said...

"Calgary may have already burned themselves out in a frenzy of building and soaring prices, but Toronto's rise as a global city will allow it to ride out any short-term weakness, they say."

http://www.financialpost.com/
story.html?id=552055

Same old BS. They said about San Diego, Phoenix (the fastest growing city in the US), Miami, Calgary...So much smelly breath coming from those developers.

talus said...

I occasionally skim through Mish's Bog and stumbled on this dandy post with some great Canadian content.

Here is the the hook...

US and Canada Demographic Time Bomb


The charts show the ratio of workers to non-workers will peak within the next 4 years or so in both the US and Canada. Workers vs. pensioners in the US is peaking now. Workers vs. pensioners in Canada has already peaked.

Fewer workers, making less money than their parents will be supporting both social security and more importantly medical expenses (Medicare) for retirees. Retirees who think home prices will keep financing retirement, need to start thinking again.

Home prices are falling and will likely continue to fall for another four years or so.

Anonymous said...

Being a homeowner, and particularily a rental landlord really sucks. We bought our rental about 5 years ago for about $330,000
We had to pay out of our pockets an average of $600 per month. Of course, the mortgage is declining about $800 per month and the home has gone up in value some $250,000.

Fortunately we are able to increase our rents annually and have adjusted to market through tenancy turnovers (they've been real troublesome with 1 turnover about every two years.) We now break-even on a cash basis and will have to pay the income tax department for the fact that we are making positive returns. What a drag.

Oh ya, we bought our own home 3 years ago and could sell it now for some $200,000 more than we paid. Howeownership is a total rip-off.

Do bears s**t in the woods? Not sure, but there's an aweful lot of BS flyin' around here.

Enjoy that windy day..

roger said...

anon 6:38 said:

Do bears s**t in the woods? Not sure, but there's an aweful lot of BS flyin' around here.

Anon, no one hear will disagree with the fact that real estate has done well over the past five years. I don't think anyone, including you, thought that prices would appreciate as much as they have in this period.

This blog is not about looking in the rear view mirror at what real estate has done in the past as that is self evident. We are looking at what will happen in the future!

Now your property is only worth what it will sell for in the future - not last month or last year. Perhaps you might like to offer your prediction, based on statistical data or reasoned arguments as to why you believe it will keep going up in the future. Or are you just a Real Estate Believer® waving your arms with nothing to share of any substance.

S2 said...

I have been told by a very good source that there is an 8 month supply of single family homes in Sooke. Take it for what you will.

patriotz said...

Anon 6:38 has given us an excellent argument as to why right now is an excellent time to sell not to buy. Unfortunately he/she doesn't realize this and will no doubt hang on to that rental all the way down the upcoming bust.

Not much fun watching 200K go up in smoke. Unless you're waiting to buy.

roger said...

S2 said:

I have been told by a very good source that there is an 8 month supply of single family homes in Sooke. .

On May 10 there were 174 active listings and only 23 April sales (7.6 month supply) as shown in this graph. Note that this is overall; things get worse over 400K. Today there are 184 houses for sale. I hope Tim and the gang sold more than 23 this month.

S2 use mls.ca and check out all the KIV Sunriver houses for sale.

olives said...

anon, I'm pretty sure we'd all agree here that real estate has gone up a lot in value in the past five years, I think that is well known a fact, not B.S.

patriotz said...

No, RE has gone up a lot in price, not value.

Value is what you get for your money.

Anonymous said...

"Perhaps you might like to offer your prediction, based on statistical data or reasoned arguments as to why you believe it will keep going up in the future."

Didn't mean to barge in and interrupt your lunch guys and gals. Actually I didn't say anything about expecting the market to continue up. My BS comment is in relation to the hugely exagerated chicken littles. We see a property (actually a bunch of properties) list some 50 - 70 K over what they'll sell for, couple weeks go by and the price comes crumbling down. "Get out of the way boys, here she comes..." now that's BS. They were over priced and now are adjusting towards actual market - not a sign of a crumbling market. Those owners are likely to settle for less than they may have gotten had they not been so greedy.

As far as my prediction for the near future: relatively steady as she goes, inventories going to remain high and prices will remain sticky (could be up or down some 5 over a year or two. It may simply go back to low inventory and stagnant prices.

We didn't buy our rental or our home with the great expectations that have come to fruition. We won't be selling for at least 10 years at which time the mortgage will be paid off. Selling now would give the government about 20% of our gains, no thanks, maybe sell the house to the kids in the future, God knows I don't want them trying to get into this mrket in 10 years time without my help.

If the market does come back down 30% (not going to happen) we will be prepared to buy at least 1 more property, maybe two. I know of lots of people of the same mind-set. The investment will keep prices mderately higher. For those considering moving away if prices don't come down, I wouldn't waste any more time. I hear Prince George is a pretty good deal.

You know what I did just before the 01 / 02 stock bubble? Got out of risky stocks and into the real estate market, but it's all hindsight. Where to next?...That's is a tough question.

Toronto real estate agent said...

I am also working as a Toronto real estate agent and I think that it is not so easy to say what is better. There are many more factors not just the ratio you’ve mentioned. And one more think, you’ve mentioned that downpayment money are kind of a loose against their second use but I think that investment in to real estate is same like any other investment.