OC Housing News clarifies the rent versus buy decision
The updated OCHN rating system helps buyers evaluate each property on the MLS for its ownership value relative to renting.
Rental parity is a simple idea, as many of life’s most powerful concepts are. Rental Parity is the point where rent is equal to the monthly cost of ownership. When rent and the cost of ownership are imbalanced, it often signals individual properties or entire markets are overvalued or undervalued.
I used a basic understanding of rental parity to determine the California housing market was a bubble and avoid buying into it. I used the same concept to identify undervalued properties in Las Vegas and buy when prices were depressed. I put my money where my mouth is, and it served me well.
I expanded on the rental parity concept to create detailed housing market reports, and develop the analysis of each for-sale property on the MLS found on this site. I want to bring the power of rental parity analysis to everyone and enable them to benefit financially from its power.
Success comes from a willingness to work to develop a simple idea. Many people have good ideas, but few work diligently to do what’s necessary to build upon and expand that idea to better peoples’ lives. I believe passionately in the usefulness of rental parity as a tool to help people make better real estate decisions.
In late February, I unveiled the new website and its many calculations. I’ve spent many months debugging, and I finally feel the site is working the way I want. Recently, I made a fairly significant change to the rating system that I believe will add value to buyers using this site.
The new OCHN property rating system
The rating system I use in my monthly housing market reports looks at rental parity along with other market performance measures to determine a rating. I believe this method produces a better and more accurate timing model concerning overall market trends.
I took this same approach when determining a rating for individual properties, and it worked; however, the rating system was too complex. I had a teacher in college who said “Beauty is the simplicity on the other side of complexity.” Like the Zen meditation garden Ryōan-ji, sometimes removing extraneous elements improves the final product.
To simplify the system, I removed the adjustment for historic values. As a result, the beach communities list fewer highly rated properties, but this isn’t a problem because people buying in the beach communities aren’t motivated by cashflow; they either buying for consumptive use or appreciation potential, so lowering the ratings fails to deter buyers in these areas.
Also, to simplify the system, I removed the adjustments for overall market conditions because market conditions rarely impact current buying decisions, and the adjustment tarnished many good deals.
The combined effect of the rating adjustments made the system an impenetrable black-box; the intuitive understanding necessary to engender user acceptance was missing. Simplifying the rating makes it easier to understand, more intuitive, and more likely to be accepted by first-time users.
Rating based solely on rental parity
The rating system on every property shown on this site — which includes the entire SoCal MLS, and very soon will include San Diego County — the rating system is now based solely on rental parity. Properties at or below rental parity are rated 7 or higher, and properties above rental parity are rated 6 or less.
I could have eliminated the rating system entirely and just used the valuation percentage also shown on each property, but this is less intuitive and harder to grasp. Remembering that negative numbers are good and positive numbers are bad confuses many people, and determining relative values is even more difficult. A scale of 1 to 10 is immediately understood by even first-time users, and it’s relationship to valuation and rental parity reinforces the power of the rental parity concept.
I think it’s a good change, but feel free to comment if you disagree or have other ideas.
And thank you for your continued readership and use of the tools on this site. It’s my pleasure to serve.
It may be the biggest financial decision most of us ever make: Buy a house? Or keep renting?
For a while in the wake of the housing crash, the answer was pretty clear: If you could swing it, buy now.
But things have changed rapidly. Prices in Southern California have climbed by a third in two years. The post-crash bargain bin has been picked clean. Yet doubts linger about the health of the housing recovery, and the broader economy.
That has a lot of would-be home buyers eyeing the market more carefully. They’re weighing the new higher prices against interest rates still near record lows, deciding between the flexibility of renting and the potential long-term payoff of homeownership. And many are looking at a job market that still feels a little wobbly and wondering whether now is the right time to take the plunge.
The conditions change, but the question remains the same. It’s very difficult to time the housing market — which is one of the reasons I developed my monthly housing market reports — but irrespective of the changing winds of the market, the analysis of individual properties is constant: it’s either a good deal versus renting or it’s not.
What’s been lacking in the past is a good and reliable method for evaluation every property for sale in the market. For buyers to perform their own rent-versus-own analysis on every property they were interested in would take far too much time and effort. Having that data and analysis available to buyers was the main reason I commissioned the custom IDX system on this site.
All this is one reason why home sales in the Southland fell 10.4% through the first half of the year, according to figures from CoreLogic DataQuick. Even as buyers are shaking off the effects of the recession, they’re confronting prices that are no longer very recessionary at all.
“People still have this idea that houses are still more affordable, which, compared with their highest points before the crash, they are,” said Natalie Lohrenz, director of counseling at the Consumer Credit Counseling Service of Orange County. “But they’re getting out of reach again for a lot of our typical clientele, which is middle-income people.”
My monthly reports still show housing as relatively affordable compared to historic norms — which means that housing is typically ridiculously expensive in Coastal California. Since supply is in chronic shortage, people who want to live here are in constant competition with one another, so housing is only as affordable as lenders enable buyers to make it.
Still, despite the dents of the housing crash and the new higher prices, survey after survey of renters suggest that most do plan to buy. The question is when.
In some ways, it boils down to simple math …
A recent study by lending giant Fannie Mae found that the homeownership rate among “prime” first-time buyers — married couples in their early 30s with a college degree, a child and household income of at least $95,000 — fell by more than eight percentage points from 2006 to 2012. When those people move, only a bit more than half now are buying a house, the study found, compared with three-quarters of them six years prior. This is despite homes being relatively cheap for some of those years.There are financial reasons for this — tight lending requirements, high student debt, an unsettled job market — said Pat Simmons, director of strategic planning in Fannie Mae’s economic research group. But some of it, too, stems from a changed perspective after the housing crash. The idea that a house is always a good investment got thrown out the window.
“Baby boomers saw a decline of nearly $1 trillion in home value during the bust,” Simmons said. “Younger folks saw that experience among their parents. I think that’s going to leave an impression.”
Weak wage and job growth, prudent lending standards, and excessive student loan debt all hinder Millennials buying houses, but reluctance to pay high prices, particularly after witnessing a painful bust, is also on the list of reasons people aren’t buying today.
That may be a healthy thing, said Lohrenz, if it keeps people from stretching too far to buy a house on the assumption that its value will catch up. Many would-be buyers figure they can make the mortgage payment, but they don’t necessarily budget for all the other stuff — taxes, condo fees, maintenance costs — that go along with homeownership, not to mention the transaction costs of buying and selling a house if you plan to live there just a few years.
“The biggest challenge for us is helping people be really realistic,” she said. “A big part of the housing crisis was people not knowing what they were getting into.”
I believe my work on rental parity, and in particular on the cost of ownership, helps people be realistic about their housing costs. If people have better information — and no other websites provide this much information with the accuracy and detail this site provides — if people have better information, they make better decisions for themselves and their families.
But even for those who are well-prepared, the decision to jump in can be daunting.
Cedric Shen and his wife have been “aggressively looking” for a house to buy for about three months, but they’ve yet to put in an offer. They’ve looked all over, from Eagle Rock to Redondo Beach, but haven’t found anything they really like at a price that seems right.
“We’re fully qualified for a loan. We’ve got good credit and no debt. You’d think it would be easy,” he said. “But you’ve got inventory issues, and you’ve got prices that seem ridiculous.“
The prices do seem ridiculous. Take a quick look at today’s featured property below. It’s an old, small, pergraniteel flipper house in Costa Mesa selling for $620,000. When you look at the house and look at the price, emotionally, it just doesn’t feel right.
Remember, Dr. Housing Bubble’s real homes of genius. He found the most dilapidated crack houses in LA asking obscene prices as emotional evidence of a housing bubble back in 2006. It was a very powerful series. Many of the prices today give home shoppers the same negative emotional reaction.
So what is different today?
Mortgage interest rates.
The prices of the housing bubble that were insanely stupid eight years ago are coming back. The only reason they don’t look as ridiculous today is not due to wage inflation, but entirely due to the difference in cost of ownership created by 4% interest rates rather than 6.5% rates. Since people know their wages haven’t gone up very much, they have the same reaction today that they had eight years ago.
If we had the same interest rates we had during the bubble, house prices today would be just as insane. A 40% drop in interest rates doesn’t have the same emotional impact as a raise at work because lower rates are intangible, but their effect is real.
Take a look at the cost of ownership of today’s property. The cost of ownership is just over $2,150 per month. The least expensive nearby similar rental property went for $2,850, and others were much higher. A comparable rental rate of $3,000 is reasonable for the market. Despite it’s high purchase price, I believe this house is a good deal, at least financially.
This is the power of rental parity analysis. It can help people set aside their emotion, either euphoria in a boom or despair in a bust, and determine dispassionately whether or not a specific property meets the family’s financial goals in addition to their emotional needs.
If you haven’t already done so, I invite you to check out the property search and the property details on the site. I’ve also added more information on comparable resales and comparable rentals in tabs on the property details sheets. Let me know what you think.