Buying Cheaper than Renting?
Online real estate site Trulia made headlines this week by announcing its conclusion that buying a home had become cheaper than renting in 98 of the 100 largest U.S. metro areas. What exactly is meant by “cheaper”? What assumptions were made in the analysis? Let’s take a look under the hood.
What Is Trulia?
From Trulia’s website:
“Trulia is an all-in-one real estate site that gives you the local scoop about homes for sale, apartments for rent, neighborhood insights, and real estate markets and trends to help you figure out exactly what, where, and when to buy, sell, or rent. You can can also find a real estate agent, view prices of recently sold homes, and see home values in your community. Get advice and opinions from local real estate agents, brokers, and other local experts on Trulia Voices, Trulia’s online real estate community.”
Trulia compiles what it calls a Rent vs. Buy Index. There’s a handy slide show presentation explaining the Winter 2012 Index, just released, at the end of this post, but to excerpt some highlights:
Trulia’s index is, on the surface, simple:
→ Index value = Asking Sale Price / Asking Annual Rent
So if the Asking Sale Price = $200,000 and Monthly Rent = $1,500, the Index =
200,000 ÷ (1,500 x 12) = 11.1.
The figures Trulia uses in the calculation are “after adjusting for property attributes and neighborhood attributes.” I’m not sure exactly what that means, and the adjustments made are not explained anywhere I could find on Trulia’s website. Just an observation.
Rent vs. Buy Index Use
Trulia “interprets” its Rent vs. Buy Index like this:
- Index is less than 15: Buying is cheaper than renting for those intending to live in the home at least 5 years.
- Index is between 15 and 20: Depending on the prospective homebuyer’s tax bracket and intention to itemize deductions, either renting or buying could be the better financial option. In other words, if you’re not going to deduct mortgage interest and property tax from your taxable income and reap substantial tax benefits (because you’re in a relatively high bracket), you’re better off renting.
- Index is more than 20: Renting is cheaper than buying, unless you intend to live in the home at least 15 years.
An important note accompanies Trulia’s Index parsing: “These interpretations take into account estimates of the additional costs of homeownership or renting, such as insurance, maintenance and so on.”
Again, I couldn’t find an explanation of the estimates made, so it’s impossible to evaluate their reasonableness or applicability to a specific situation.
If you page through the slide show, you’ll see a list of the top 10 metro areas with the lowest index—those where buy vs. rent leans most heavily toward buy—and the 10 metro areas with highest index, which favors renting. Buy is most favored in Detroit with an index value of 3.7, and least favored in Honolulu where the index = 17.0. No metro area has an index over 20, interpreted by Trulia as favoring renting except when a buyer intends to stay in the home at least 15 years.
I can’t have an informed opinion on the Trulia Rent vs. Buy Index without access to a lot more information. For example: How are the Index’s two components adjusted for property and neighborhood attributes? What assumptions are made for the significant costs—besides mortgage interest and rent payments—that typically go along with either ownership or renting? How does a choice between a fixed and variable rate mortgage factor into the Index? And perhaps most importantly: Exactly what rationale underlies the assertion that a Sale Price / Annual Rent ratio under 15 means buying is cheaper?
Assuming Trulia’s been consistent over time in compiling its index, one could surely conclude that buying has become far more affordable, compared to renting, and that’s useful to know. Folks formerly priced out of the home market may now be able to afford a home, if they can get a loan.
I think the index is also useful in comparing metropolitan areas. If you’re keen to buy a home and want to get the most bang for your buck, head to Detroit, Oklahoma City, or Dayton, and stay away from Hawaii, San Francisco, and New York City. Trulia also provides data within a few metropolitan areas (New York, San Francisco, Chicago, and Los Angeles) which would be useful for people looking to buy in those metro areas. For example, Trulia’s Index varies in the Los Angeles area from 15.8 along the coast (better to rent) to 9.8 in Riverside (better to buy). I’m not familiar with Los Angeles, but I suspect considerably more than cost may be involved in the choice between buying a home in Westside LA vs. Riverside.
Using the Index
Though I think using the Index for comparison among cities or among neighborhoods within a metro area can be helpful, I would not use the Index to make a judgement about a specific situation.
For example, if I were considering whether to buy or rent in the Albuquerque area—Index = 11.9, interpreted by Trulia to mean buying is cheaper than renting for a 5-year or more horizon—I would not take for granted that I should buy. Each house and each neighborhood is different, as any real estate professional will tell you. Also: Are home prices still falling? Are rents likely to rise in the near term at a higher than typical rate? Can I qualify for FHA mortgage insurance? Is the particular house in which I’m interested in good repair or of an age and condition likely to require higher than average maintenance costs? Will I have to pay association fees? Is the house in a desirable school district or benefit from other intangibles likely to buoy value? Could I save significant commuting expense by renting near work, where I can’t afford to buy a home? Do I have savings to cover the inevitable cost of maintenance if I buy a home?
The only way to reach the right conclusion for you is to, as the expression goes, “run the numbers” for your situation, factoring in your personal goals and plans, and for specific purchase and rental opportunities. If you don’t feel qualified to do this on your own, hiring an accountant for a couple of hours may be worth the investment.
What do you think of the Trulia Rent vs. Buy Index? Is it useful? Meaningful? Self-serving? Subject to mis-use?