Housing mess makes buy vs. rent choice harder

When it comes to the home, the standard advice is simple: Over a lifetime, it’s better to own than to rent. As a homeowner, you build equity until you own the property free and clear. Renters are never free of monthly payments.

Owning is a no-brainer, right?

Not so fast. Today, with the real estate market in turmoil from the subprime mortgage debacle, many people may be better off renting — for the next few years, at any rate.

The rent-or-buy decision has two parts — the mathematical and the personal. It’s the math that has changed. Home prices are falling in much of the country. That should be good for buyers, except that many experts think prices will fall even more — by 10 to 15 percent, according to some projections.

Buy today and you could soon find your home is worth less than you paid — and less than you owe the mortgage company. Imagine if you had to move for a new job, to get more space for a growing family, or to get a cheaper place after losing a job or spouse.

Meanwhile, rents have fallen in many places, mainly because real-estate speculators who bought during the recent boom find they cannot sell the properties they’d hoped to flip. They’re trying to rent their properties instead, and the surge in supply pushes rents down. Some landlords are reducing security deposits, offering the first month rent-free or even throwing in utilities, not a small incentive considering high energy costs.

Recently, three Federal Reserve economists — one former and two current — looked at the long-term relationship between home prices and rents. They found that from 1960 through 1995 annual rents averaged from 5 to 5.25 percent of home prices. Then the figure started falling, reaching 3.5 percent at the end of 2006. In other words, rents are unusually low relative to home prices, and to get back to normal rents would have to soar or prices to plummet.

Imagine a typical case: In buying a home you pay real estate transfer taxes, lawyer’s fees, mortgage application fees and other closing costs that altogether come to 5 percent of the property’s sales price. And assume that if you were to sell the home you’d pay a 6 percent Realtor’s commission. The property would have to appreciate about 11 percent before you could sell it for enough to offset these costs and break even.

If the home appreciated at the average long-term inflation rate of 3 percent a year, you’d have to own it about four years to break even. But if the property’s value fell by 10 percent over the next year or two, you might have to own it twice as long to break even – for eight or 10 years, maybe longer if the downturn were prolonged.

As a result, renting starts to look more appealing.

That’s the big picture. But to decide whether to rent or buy you have to look at specific properties — one for sale and one for rent. (Unless, of course, you find a place offered for sale or rent.)  Once the specifics are available, you can key the numbers into an online calculator like the one you can access at Bloomberg.com.

Good calculators go far beyond comparing the monthly rent on one property to the monthly mortgage payment on another. They also look at investment gains you might make if you rented and invested the money that would have gone to a down payment had you bought.

They will take into account the fact that rent is likely to rise year-by-year while the principal and interest payment on a fixed-rate mortgage will stay flat for decades. They’ll factor in the tax deduction you’d get on your mortgage interest payment and real estate taxes, and they’ll figure the rising value of the home you buy – the “equity” you build up.

In the end, these calculators tell how long it will take to break even on a home purchase. That’s the point at which the benefits of owning, such as growing equity and flat monthly payments, outweigh the extra costs of owning vs. renting, such as closing costs and, perhaps, higher monthly payments for a number of years. If you expect to own the home past this break-even point, buying makes sense. If not, it doesn’t.

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