Wednesday, January 5, 2011

Don't take my word for it...

Here at SIREN, we have been talking about now being a great opportunity to buy a home, if you are planning to be in the home for more than five years. This article from Bloomberg BusinessWeek reiterates that and says more pointedly that "Now may be a once-in-a-lifetime time to buy."

Here are excerpts from the article...

A pall has settled over the U.S. housing market. The first-time home buyer's credit has dried up, and home prices are down 29 percent from their 2006 peak. On Dec. 9 the latest release of the Federal Reserve's Flow of Funds data shows the value of homeowner equity in the third quarter of this year at $6.4 trillion—52 percent lower than four years ago.

But does that mean it's a bad idea to buy a home? I don't believe so, based on some dispassionate analysis. For the long-term homeowner (or patient investor), a home appears to be one of the better investments around, with minimal downside risk. "Housing is priced to earn its historic real rate of return of 0.5 percent to 1 percent and interest rates are low," says Morris Davis, professor of real estate and urban land economics at the University of Wisconsin-Madison. "Now may be a once-in-a-lifetime time to buy."


Think of the rental and ownership markets as competing for the household shelter dollar. Richard Green, director of the Lusk Center for Real Estate at the University of Southern California, says that equation clearly favors owning. Even more striking, Green says he's "hard-pressed to think of a time when owning on a cash-flow basis looks so reasonable relative to renting."

Take this back-of-the-envelope calculation: Green notes the median U.S. house price is $170,500. The most recent American Housing Survey data (2008) put the median rent at $808 a month and the CPI-Rent index has been essentially flat since then. The cash-flow cost of renting is $9,696 per year. On the homeownership side, Green assumes an interest rate on a 30-year fixed-rate mortgage is 4.5 percent and that the buyer makes a 20 percent down payment. He assumes the buyer could have made 10 percent on the downpayment if it was invested elsewhere, the so-called opportunity cost of capital. Property taxes are 1 percent of house value, marginal income tax rates (state and local) are 25 percent, maintenance costs are 1 percent per year, and amortized closing costs are another 1 percent per year. Taken altogether, the cash cost of owning is $12,162 per year. Looks like renting still beats owning, right?

Not really. The typical apartment is smaller than the typical house, 1,300 square feet for the median rental unit vs. 1,800 square feet for the median home. Thus, owning the median home is about 10 percent less per square foot than renting the median rental unit. "You need no home price appreciation to still be ahead financially with owning," he says. "Your after-tax, out-of-pocket cost of owning is less than the out-of-pocket cost of renting."


There's another trend working in homeownership's favor: "Housing is a hedge against inflation," says Davis. During the inflationary 1970s the annualized real rate of home price appreciation—that is, above inflation—was 4.35 percent for the decade, according to research by Davis and Jonathan Heathcote, economist at the Federal Reserve Bank of Minneapolis. In sharp contrast, from 1960 to 1970 the real annual return was 0.62 percent. Thanks to the potent combination of leverage and inflation, the average homeowner in 1970 earned a total real return on equity of 5 times by 1980.

The housing market bust has taken optimists to the woodshed many times over the past several years. The litany of negatives weighing on the market remains daunting. So the safe forecast remains "Plenty could still go wrong." But real estate market valuations suggest the odds may well favor the intrepid.

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