Renting in and Around Seattle Still the Smart Financial Move

Let’s take an updated look at some Seattle-area rent vs. buy comparisons to see if the situation has improved at all since we analyized it last summer. Back then, the real-world example I used compared two similar homes in Kirkland. Total monthly costs for the rental were \$1,515, while the home for sale would have cost \$2,690 per month—a difference of \$1,175 in favor of renting.

For the purpose of our comparison, we will again assume that the potential home buyer or renter is a married couple with enough in the bank to make a 20% down payment and are qualified for a 30-year fixed-rate loan at current rates (5.75%).

In today’s first comparison, I found two homes in Kirkland.

For rent—4-bed, 3-bath, 1,800 sqft house with a 2-car garage. Monthly price: \$1,495.
For purchase—4-bed, 2.75-bath, 1,900 sqft house with a 2-car garage. Price: \$400,000.

I’m not going to go over exactly how all the values below were calculated, since it has been covered extensively before. If you would like to follow along at home, feel free to download my spreadsheet that will calculate the costs for this or any other set of inputs.

 Renting Buying Rent/Mortgage: \$1,495 \$1,867 Insurance: \$20 \$163 Property Tax: – \$383 Tax Savings*: – (\$254) Maintenance: – \$333 Total: \$1,515 \$2,492

*: (year 1 only, less standard deduction)

In today’s comparison, the monthly savings from renting has dropped slightly down to \$977. But how does the financial situation change over the next five or ten years? Let’s add a few more assumptions. 1) The house appreciates an average of 1% per year (probably generous). 2) You can invest your cash and get a 2% rate of return. 3) The renter adds the \$977 monthly savings to their investment. 4) To realize any cash gains on the house will require paying 6% to agents and 1.78% in excise tax. 5) Interest earned on your cash investment is taxed yearly according to the 25% tax bracket. 6) Rent increases at 3% per year.

Given those assumptions, after 5 years today’s renter would have \$145,000 in their investment, while the buyer would net just \$91,000 from the sale of their home. After 10 years, the renter has \$208,000, and the home buyer that sells will walk away with \$141,000.

Let’s run the numbers for another pair of homes, this time closer in, in the ever-popular Ballard.

For rent—3-bed, 1-bath, 2,180 sqft house with a no garage. Monthly price: \$2,195.
For purchase—3-bed, 2-bath, 2,100 sqft house with a 1-car garage. Price: \$550,000.

 Renting Buying Rent/Mortgage: \$2,195 \$2,568 Insurance: \$20 \$163 Property Tax: – \$527 Tax Savings*: – (\$433) Maintenance: – \$458 Total: \$2,215 \$3,283

*: (year 1 only, less standard deduction)

So over in Ballard today’s renter will save \$1,068 a month. With the assumptions stated above, after 5 years the renter has \$181,000 in the bank, while the buyer gets \$125,000 from the sale of their home. After 10 years, the renter has \$246,000, the buyer gets \$195,000.

I’m certainly not one to say that no one should buy a home ever, but the way things look around Seattle at present, renting for now is still clearly the way to go. Remember that the rentals in my comparison were nice, large houses. If you can stand renting a smaller apartment for a while you’ll be saving even more.

Of course there are always exceptions to every scenario. I’m sure there are people out there today finding amazing deals from highly motivated sellers. If you find such a deal, more power to you. But for most of us, renting in Seattle is still the smart financial move.

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Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market. Tim also hosts the weekly improv comedy sci-fi podcast Dispatches from the Multiverse.

1. 1

THE BOTTOM LINE

Another great pragmatic take by The Tim.

All you have to do is look at the monthly costs The Tim mentioned minus any tax advantages [if any] over the federal tax standard deduction [rentors get that anyway] and add in recent lost YOY equity [divide by 12]. If you sell and pay the 5-7% realitor fees plus any escrow closing costs; with the most likely horrifying costs of fixing it up to sell for the least loss…..you get the picture, if you don’t own a home for at least five years [assuming it goes up in value with inflation….lol], it generally costs more to sell it than to hand the keys back to the bank.

The 5 year rule has been fairly standard on the average for decades in Seattle now.

2. 2
Joel says:

I did a rent vs. buy comparison just a few months ago and it came out even more in favor of renting. The cost of buying would’ve been more than double. However, that is specific to our situation so make sure to run the numbers for your own situation rather than complain that others’ assumptions are “unrealistic”.

3. 3
SeattleMoose says:

Well done Tim. Excellent analysis.

4. 4
Interloper says:

I just wish it was easier to find that reasonable rental house.

There have been some resources posted on this site before, I know, but it is truly difficult to find what you’re wanting in a rental house (neighborhood, features, price).

5. 5
98115renter says:

So my only prob with the analysis is that it assumes a 1% appreciation per year. While that may be realistic if you factor in current declining home values and a short term time horizon, it’s just as likely to be WAY off. Including the current deflation (even if you include another 10-20% drop), what is the historic mean annual appreciation in the Seattle area? My guess is that it is much higher than 1%.

I rent a fixer in 98115 for \$1200/month, but just yesterday I saw a comp in Ballard for sale for \$220k. Anyway, I think the old assumptions are starting to fail and there are true bargains out there that might throw off this whole analysis.

6. 6
vboring says:

The biggie is rent and house price inflation. I think housing is generally overbuilt, so rents will stagnate while house prices fall. 5 years from now, I think houses will be lower than they are today. 10 years from now, they may be at break even.

The return of no risk investment today is the 10 yr treasury at 2.78%, so your 2% estimate is low. CDs can be had for 4%, but that rate of return isn’t guaranteed. Given P/E ratios in the market today, historically have indicated a high rate of return so a diversified stock investment could net 8% over the next 10 yrs. A house isn’t a zero risk investment, so why should the alternative be riskless?

The 6% realtor fee is too high, given the number of realtors competing for sales today and the likely universal acceptance of discount realtor sites like redfin 10 years from now.

All in all, I think your estimates are too strongly in favor of buying.

7. 7
The Tim says:

98115renter @ 5,

That’s why I didn’t forecast out further than 10 years. I definitely don’t think that 1% is a reasonable number if you’re estimating further out, but I think it’s reasonable in the somewhat-near-term.

Here’s one situation over the next 10 years that averages out to around 1% per year:

Year: Annual Appreciation
1: -10.0%
2: -3.0%
3: -1.0%
4: 0.0%
5: 1.0%
6: 4.0%
7: 5.0%
8: 5.0%
9: 5.0%
10: 5.0%

Looks fairly reasonable to me, if not possibly a little on the generous side. Also, a situation like the above set of numbers comes out to -2.7% per year for the first 5 years of the period, so one could easily argue that 1% is too generous.

The point of this post was not to compare lifelong renting with buying, but short-term renting (up to 10 years) vs. buying.

8. 8
Lake Hills Renter says:

My single, mid-20s coworker is about to drop \$560k on a house, and has been praising the idea of getting an Option ARM. Apparently he made an offer today.

9. 9
vboring says:

the WSJ thinks that home loan interest rates will be set at 4.5%

http://online.wsj.com/article/SB122833771718976731.html

that’ll screw up your mortgage costs, could slow the price declines, but would depress rental costs.

10. 10
98115renter says:

The Tim, thanks for showing where you got your 1% figure from, makes sense. I do think though that there are deals popping here and there that would be considered huge markdowns (bigger drops than the MLS numbers) that might insulate one a bit from further drops, and might start to come close to rental rates.

11. 11
alex says:

So… what if you pay cash? Or if you have a big downpayment, say 50%? I think that’s then renting starts to become unfavorable.

12. 12
Magnolia44 says:

I think we see sub 5 rates soon bill gross pointed that out this am as well. This goes with my kitchen sink theory with the govt and housing. We still have a ways to go to see it happen but it or something like it will.

13. 13
Another Tim says:

The clear message seems to be; if you are ready to put down roots and stay where you are then buy a house. If you do it right the house is paid for in 15 years and you’re in good shape for a long time. I say this under the assumption that the purchase is not made in the middle of an out-of-control pricing bubble.

14. 14
Joel says:

So… what if you pay cash? Or if you have a big downpayment, say 50%? I think that’s then renting starts to become unfavorable.

Think of this post less as an exact representation of the situation of every single reader of this blog and more as motivator to get people to run their own numbers and figure it out for themselves.
During the bubble years there were far too many people implicitly trusting the media and the RE industry when they pumped buying over renting at any cost. If we can get people to think for themselves a little it would be a huge victory no matter what their end decision is.

15. 15
deejayoh says:

the WSJ thinks that home loan interest rates will be set at 4.5%

http://online.wsj.com/article/SB122833771718976731.html

that’ll screw up your mortgage costs, could slow the price declines, but would depress rental costs.

all that will do us succeed in absolutely stalling all sales until it is put in place – which it probably won’t be

So… what if you pay cash? Or if you have a big downpayment, say 50%? I think that’s then renting starts to become unfavorable.

so I guess you are happy with 0% return on your money then? Great. come talk to me. I’d be happy to handle your investments for you.

16. 16
Yesler Hill says:

I would like to disagree with the notion that you can only put down roots in a neighborhood as a property owner. In the city it should be possible for renters to sustain residence and job. Some rent stabilization mechanism would help do that.

I’m a life long renter by choice, I’ve been in the same building for 15 years. If I had more rent price sustainability built into being a renter, I’d never move.

I do a very unscientific look at rental listings on craigslist for Capitol Hill in a rent rate several hundred below last years going rate. In August I was seeing 20-30 listing in the range. This week, 120-150.

I know, completely unreliable methodology – but, I also think that the rental market is just starting to catch up with the reality of over building in Seattle and Bellevue, and their environs, and the broader the economic depression.

17. 17
Another Tim says:

re: #16
The “notion” is only in your mind. If you’re happy renting that’s great. I would never imply that you’re less of a neighborhood “member” just because you’re renting.

There are other benefits to ownership than getting a good ROI. Even in light of government control of what used to be “property rights” you can still add on to the building and/or make other changes of your own desire without having to consult a landlord. It’s not always about the money.

18. 18
Joel says:

The “notion” is only in your mind.

If by “only in your mind” you mean “a widespread stereotype” then I agree with you.

19. 19
jon says:

“With the assumptions stated above, after 5 years the renter has \$181,000 in the bank, while the buyer gets \$125,000 from the sale of their home.”

So if you can haggle the price down 10% on the list price of \$550K on this house, you come out ahead of renting after 5 years. By then the deflation from the housing collapse would have been long gone and the high taxes and inflation to pay for the bailouts will be driving rents and deductions at that point.

I would be interested in a closer look at the listings of two units being compared, because anecdotally, houses for sale are in better shape that those that are rented out.

20. 20
Alan says:

So… what if you pay cash? Or if you have a big downpayment, say 50%? I think that’s then renting starts to become unfavorable.

Tim doesn’t include lost income from the capital sunk into housing. If the hypothetical buyer above puts 20% down on a \$550k house, then he loses that 2% rate of return on \$110k. That comes out to a \$183/month in decreased income.

If the buyer puts down 50%, the \$225k at 2% loses \$375/month of income.

At 100%, the buyer loses \$916 a month.

Suppose they pay 100% cash and rent it out at \$1200/month. Property taxes and maintenance comes to about \$975 according to the estimates above. That means they are earning \$225/month on their \$550k investment. That is 0.5% return. Combined with the 1% annual appreciation, they are getting 1.5% return instead of 2% return for the hypothetical cash investment.

Equilibrium theory predicts that the house purchase should be the same as any other investment. Based in the assumptions above, either the house price would have to drop or the rent price would have to rise so that the cash buyer can earn 2%. Either the rent has to go to \$1430 or the house price has to drop to \$270k.

LIkely it will be a mix of the two, but from a risk analysis perspective, do I feel safer about paying an extra \$230/month or losing \$280k in working capital?

21. 21
deejayoh says:

I would be interested in a closer look at the listings of two units being compared, because anecdotally, houses for sale are in better shape that those that are rented out.

N=1, but I’m renting a townhome for \$2100 a month. Identical unit in the same complex sold in July for \$675k.

that’s a 26x multiple of price:rent. That is much higher than either of Tim’s examples (@ roughly 22x and 21x) and these are identical units

Since most people on this blog would probably tell me that I am paying too much rent, I don’t think the examples are at all unrealistic.

22. 22
deejayoh says:

Tim doesn’t include lost income from the capital sunk into housing. If the hypothetical buyer above puts 20% down on a \$550k house, then he loses that 2% rate of return on \$110k. That comes out to a \$183/month in decreased income.

If the buyer puts down 50%, the \$225k at 2% loses \$375/month of income.

Blast you Alan! I had a money management proposal out there and you blew it for me :^)

23. 23
Another Tim says:

#18 no problem.
I just wanted to let YH know I wasn’t making that implication.

24. 24
Curtis says:

I sold my house end of 06 and now I am keeping over 800k cash living in my 2 bedroom rental. I will keep renting until I feel market is stable even if it means two more years. Buying a house is an investment regardless of how much you worth. in 08 and 09, buying a house is almost comitting a suicide financially regardless of how much the seller dropped the price from original listing value. 50k drop of seller price means you will lose 100k very soon – be aware of that before attempting to buy anything.

25. 25
Alan says:

Tim doesn’t include lost income from the capital sunk into housing.

Actually, I think he does. I take it back.

Renter takes the \$110k 20% downpayment and invests it at 2%. Each month he adds \$977 to that investment.

Buyer takes the \$110k 20% downpayment an invests it in his property at 1%. Each month he adds the principle portion of his mortgage to that investment. Eventually, the principle will exceed \$977/month and he will start to catch up to the renter.

If the downpayment increases to 50%, then the renter is still getting a higher rate of return on his capital, but the difference between the mortgage and rent is smaller and the principle portion of the mortgage is larger. Using the same assumptions, the renter is adding less to his 2% investment each month and the buyer is adding more. So the buyer will surpass the renter more quickly, but only because the renter is saving less.

Suppose you kept the renter saving \$977/month. The buyer also gets to save the difference between his mortgage payment with 20% down and his mortgage payment with 50% down. The buyer should apply this against his 5.75% loan). Now the buyer is sinking more money into his 1% investment while the renter is sinking his money into 2% investment. Any guesses on who comes out ahead?

What if the buyer puts down 100%? He earns \$550k at 1% while the renter earns \$550k at 2%. But his \$975/month costs are lower than the renter’s \$1200/month costs, so we let the buyer add \$225/month to his own 2% investment pile, while the renter doesn’t get to add anything.

How long will it take the buyer to surpass the renter?

(I’m making an incorrect but simplifying assumption that the rent, property value, and return rates remain the same.)

A quick excel calculation says: never. The buyer get \$2700 at 2% and \$5500 at 1% the first year, but the renter saves \$11000 at 2% that year. The renter saves \$2800 more than the buyer and is getting a better rate of return.

26. 26
Ray Pepper says:

Curtis….800k in cash in your 2 bedroom rental!!!!!…………Hmmmmm…….Where do you live? Is it behind the toilet tank? I hope not. I had a friend in college once who left me the surprise of an “upper decker” in the tank. It was one heck of a mess.

27. 27
Ray Pepper says:

Just a passing thought…. All the people who chose not to buy in the last 6 months who instead placed their money in the stock market. It would be interesting to see how they would have faired if they bought the “GEM” instead.

I just wonder how many actually kept the money in the toilet tank?

28. 28
victorchai says:

27Ray Pepper // Dec 3, 2008 at 4:07 pm

Just a passing thought…. All the people who chose not to buy in the last 6 months who instead placed their money in the stock market. It would be interesting to see how they would have faired if they bought the “GEM” instead.

I just wonder how many actually kept the money in the toilet tank?

Sorry to disappoint u Ray…I have been shorting the stock market for the past 3 month, and buying SKF so 17% return so far this year…not alot I know,since I am not a frequent trader, but it’s better than buying those” Gem” you mentioned…thanks, but no thanks…and make sure to put your Realtor hat on when u stand by the freeway exit…

29. 29
Shaq says:

@Seattle Moose #4

Craigslist + the MLS have a huge amount of rentals, and increasing daily. Or you could just look at the properties in your area that have been on the market for a long time at hugely unrealistic prices and approach the owner about possibly renting. I’ve been doing just that, and am on the cusp of moving in next week. The sellers hadn’t even considered renting until I happened by to tell them it would be a good idea.

30. 30
98115renter says:

So how much is saved (or lost) over the years when you purchase a home outright vs that 6% interest paid to the banks for your mortgage?

How much is saved over a lifetime when after 15-30 yr mortgage you have no more monthly housing payments vs renting?

The variables are truly mindboggling. Every time I see an anlysis on here on renting vs buying I think of 10 things that could change the outcome.

31. 31
masaba says:

I would also assume that in the current market, a renter with first and last plus deposit in cash as well as good credit history should not assume that they have to pay the asking price for a unit. With the vacancy rate in Seattle rising, I would assume that landlords are starting to feel the pressure to get and keep good tenants. Therefore, you should have some negotiating power in getting a landlord to come down on the monthly rate a bit. After all, deflation cuts across all markets.

My wife and I just had our lease expire and are going to shoot for getting a new year long lease at a lower rate.

32. 32
Ray Pepper says:

HMMM. Victor you must be a newbie here. Never wore a Realtor hat. Always an investor and always will be. With a tad bit of nursing on the side. Nice work on SKF. My portfolio started with the usual \$\$ at the beginning of the year. (I never EVER put real money in the market- Just the same \$\$ at the start with AMTD) Appears I will close out the year down 23-25% with my brilliant trading. HAAA In/out of the usual EP, BAC, C, and a variety of shorts on JWN, M, and such. I got nailed on holding my EGHT too long. A CNBC junkie that brought a model to the masses for what I have been asked for the last 10 years in real estate.

Don’t CLUMP me in your basket of 30k friends at the NWMLS. Most want nothing to do with me.

33. 33
obelus says:

Dive! Dive! Dive!

Prices will drop for both rental and SFH properties to levels not seen in decades.

Anyone buying post-2000 will know they paid far too much.

Prices for any property must conform to historical models of 3x the average salary, period. Anyone calling a bottom now or in the next year is delusional or lying.

Good luck to all and a happy holiday season.

34. 34
deejayoh says:

Prices for any property must conform to historical models of 3x the average salary, period. Anyone calling a bottom now or in the next year is delusional or lying.

Please point me to the time that housing was “3x the average salary”. That is an old wives tale.

35. 35
duarte says:

There is also the percentage of the down payment that will be lost to depreciation – as well as the lack of liquidity that the down payment cash may have provided – to be considered when we buy a home. There is also the very real possibility that one may not be able to sell when one needs to. I don’t know that I could put a price on that lack of freedom if unemployment rises to the degree I suspect it may. Nope, a happy renter I will stay

36. 36
Andy says:

I don’t think I will ever buy a home. It’s worse than being long U.S. equities. No return and countless headaches.

37. 37
Jonness says:

“Please point me to the time that housing was “3x the average salary”. That is an old wives tale.”

I think it’s between 3 and 4 percent.

38. 38
johnnybigspenda says:

Remember like 1 year ago when everyone said, “when people no longer think that owning a home is a good investment, *thats* when we will know that the market has started to return to sanity”?

The bulk of the Bubbleheads wouldn’t touch real estate with a 10 ft pole right now… this thought is starting to become mainstream as well.

The sellers (who actually need to sell) are very clear on this at this point, mind you. The rest of the sellers are dreaming.

39. 39
deejayoh says:

Joness – Actually that chart shows HHI, not salary. Per Capita income is a better proxy for average salary. HHI is probably 30-40 higher than PCI

and by that measure, Seattle has been at around 6x multiple for the better part of 20 years and is currently around 8

http://img132.imageshack.us/my.php?image=housetopcihs8.png

40. 40
rent for now says:

When median prices in King county drop to 300k, I might consider ‘owning’ again. (it is quite overrated)

41. 41
Dave says:

Hi Everyone;

I think I have a challenge to those of you so inclined. Listen – the crash was easy to predict – I think we can all agree on that. My question to you is this – when will the bottom be here? When will you captialize on the bottom? I think that discussion is a much more interesting conversation at this point – since it is certainly the harder question to answer. Not talking about the turn around means you are really just cheerleading the crash isn’t it? I’m not judging – don’t think that – but more curious than anything.

Thoughts?
Dave

42. 42
what goes up must come down says:

Dave so the run up took what 5 or 6 years depending on what data you look at the run down started what a year ago so I would say the conversation you are talking about can talk place in about 2 or 3 years.

Another Tim at 17 “There are other benefits to ownership than getting a good ROI. Even in light of government control of what used to be “property rights” you can still add on to the building and/or make other changes of your own desire without having to consult a landlord. It’s not always about the money.”

YOU HAVE TO BE A REALATOR I mean that is classic — “It’s not always about the money.” — Are you serious?????

43. 43
jon says:

“Per Capita income is a better proxy for average salary.”

Household income is the total income of everyone living in the same unit, so it directly reflects the ability to pay the rent or mortgage on that unit. The per capita includes children, who generate no income, and so that number is not useful to understand affordability. Per capita is intended to show poverty levels because kids cost at least as much as adults when you factor in education, etc.

44. 44
greenthum says:

Dave:

One step at a time! We still need to convince our “spend happy” state and local government officials that there’s been a crash before we can started thinking about a turn around.

45. 45
Robert Wojciechowski says:

I think the discussion does not talk about the fact that the govt is likely to go on a rampage and try to inflate the house prices. So you can get better returns as long as the govt keeps on pumping in huge amounts of cash. Obama is set to be getting ready to bail out everybody.

My friend in Kirkland is already thinking of quiting his job for a while, missing some payments to get free handouts from the govt. Nobody is writing about loopholes on how to get a free ride here.

Here is an excerpt:
“Here’s how the plan works: A homeowner who lives in a house and misses at least three loan payments can qualify for a streamlined workout designed to reduce the monthly payment to a 38 percent debt-to-income ratio. (Principal, interest, taxes, and insurance would be no more than 38 percent of gross income.) The plan initially targets 40,000 mortgages.

To make that happen, the FDIC is extending the term of the loan to 40 years; lowering the interest rate permanently; lowering the interest rate as low as 3 percent for up to 5 years; or excluding part of the loan balance when calculating the monthly payment. (In the latter instance, the amount owed would not change and the borrower would have to pay it back when he sells or refinances.) The workout can also include some combination of the above.

Here’s how the law of unintended consequences could work in this scenario:

1. The struggling homeowner who scrimps and saves to make the mortgage payment stops paying for three months in order to qualify for a workout.

2. The borrower reduces his household income; if unemployed, he stops looking for work or takes a low-paying job temporarily (barista at Starbucks, for example). A two-income family would have one of the wage-earners quit and stay home with the kids. Once the mortgage has been adjusted based on the lower income and set for five years, the borrowers seek new jobs (or second incomes), ideally with higher wages.”
from:
http://finance.yahoo.com/expert/article/moneyhappy/126560

Lots of people bash me when I say the govt is going to do everything to inflate the prices, get into more debt to finance current debt and will just go on a complete rampage to save the system as it is. I think I am correct. I am starting to doubt there will be deflation. But who knows.

46. 46
Robert Wojciechowski says:

Also in my opinion there should be a discussion how current irresponsible homeowners can all team up to demand free rides from the govt. They can say that otherwise they will cause unemployment and will cause banks to fail. So the govt must give free reloads at once.

And then just cruize the Carribean etc.

47. 47
Sniglet says:

I think the discussion does not talk about the fact that the govt is likely to go on a rampage and try to inflate the house prices.

Certainly the government WILL do anything and everything it can to boost house prices, and flood the economy with stimulus. In the end, however, it won’t do any good. Interest rates are already at historic lows but that doesn’t seem to be goosing the housing market. Pushing rates even lower won’t help. Japan pushed interest rates to zero in the 1990s to no avail, and all the latest government stimulus attempts will fail abysmally too.

Who wants to borrow a pile of money, even at zero percent, to buy an asset that is depreciating? I’ve read articles about people who bought homes in Tokyo suburbs in 1994, after they had fallen some 30% or 40% in value, only to see them drop another 40% in the coming decade. Those low interest loans they got still need to be repaid. I am sure those Tokyo home buyers would have much preferred buying their homes at triple the interest rate if they could have gotten them at the ultimate bottom in price (which still might not have been hit, by the way, since the Japanese economy is tanking again).

I have written about this deflationary trend, and why the government is unable to do anything about it, at my blog at http://www.surkan.com.

48. 48
Sniglet says:

I should add that a further the collapse in real-estate prices will not be driven solely due to a buyers strike, as people become reluctant to buy depreciating assets. It will also be impacted by tightening lending standards and deteriorating credit quality. Lenders will continue to tighten lending criterion EVEN while they offer increasingly lower rates. This only makes sense since banks want to reduce their risk to future losses, and when prices are declining they need greater protection to ensure that they aren’t left with a loss in case of default.

Also, keep in mind that the government is demanding that lenders tighten lending standards at the very same time it is trying to boost lendning. The FDIC, for example, has passed rules that make it nearly impossible for developers to get loans these days. Numerous efforts are also under way in Congress, and various regulatory agencies, to prevent banks from returning to the loose lending practices of the bubble.

Lastly, in a deteriorating economy, more people will find their credit becomes sub-par as they lose jobs, take pay cuts, etc.

Lower mortgage rates wont help very much when the pool of possible borrowers keeps shrinking.

Just another reminder that my podcasts cover some of these deflationary phenonmena at http://msurkan.podbean.com.

49. 49
Other Ben says:

re: vboring@9

I agree, 5.75% is a sort of high interest rate to use in this calculation. The other thing that I think is a little strange is that the tax savings are “less the standard deduction”. Who only takes the standard deduction?? At the very least you can assume that for someone paying, in the 2nd example, \$2,568 a month in mortgage payments, is paying less than 37% of their income as mortgage.

At \$83,286, they would be at least be able to deduct around \$1465 for state income tax. (20% of gross income * local tax rate of 8.8% – where I live, anyway) Also, assuming the average charitable giving rate of 2.2%, that’s another \$1826. Plus, you can deduct the property tax of \$6324.

That’s nearly the standard deduction for married filing jointly right there. (\$9615) Plus, I’m sure the average person has at least something else they can deduct. (Tax paid for car license, maybe some of their housing repairs count as home improvement, some kind of other tax shelter…)

I think it’s safer to assume that the mortgage interest is entirely deductible, which would make the tax savings \$642 a month…much higher than \$274.

50. 50
stephen says:

In well over 20 years in houses maint has never run close to these numbers. Unless your buying an old fixer I wouldn’t consider this a reasonable number at all.

With the exception of a roof and of course remodeling, it is normally a lot of time and a few bucks on a regular basis. I had to spend \$850 on a water heater one time and one of my landlords did the same.

My homes were/are taken care properly.

51. 51
Robert Wojciechowski says:

I agree. But say you are a homeowner – doesn’t it make sense now to try to get a bailout from the govt? And this way it makes sense for you to stay in this shack that you bought for an inflated price?

At what point will the govt help to sustain the prices?

For example if the govt offered to pay for half of all outstanding loans – the prices would for sure go up. The issue would be how to get the money? Some people think that printing money would equal more damage because the value of the USD would just suddenly fall off a steep cliff. The question where is the equiliribium?

Also to what extent can the US look out for help from foreign countries. For example China will be in a big predicament if US consumers retreat and don’t buy the toys they are producing. So China and many other countries would be willing to do all kinds of bailouts because this will ultimately help develop their economies. Could this type of help – work its way into the system and somehow bailout all irresponsible homeowners?

Obama is a democrat who probably believes in socialist – European type policies that stifle growth in the long term but could fix things in the short term. He could try to put the US into more unsustainable debt to cover up the fact that there needs to be lots of changes. Lots of poor people voted for him and they are all for govt bailouts.

My friend who works at MSFT is already trying to figure out a strategy to siphon some of the cash that will be flowing around once Obama puts the economy into higher spending gear.

52. 52

Tim – You might also want to consider what the home would actually sell at in today’s market. Were the prices you had list prices? I would hope that anyone buying a house would get at least 5-10% off right now, depending on how accurately the home is priced.

What do you think about going off a recent sale so you know what the price closed at? I don’t think it will change the outcome much, but would probably be a little more realistic.

53. 53
Sniglet says:

My friend who works at MSFT is already trying to figure out a strategy to siphon some of the cash that will be flowing around once Obama puts the economy into higher spending gear.

Sure, it is always possible to feed at the government trough, but that doesn’t mean that the over-all economy or real-estate market will improve due to government spending. As I mentioned earlier, Japan’s government pumped masses of stimulus into the economy, just as the US did in the 1930s. In both cases the people who got contracts for large public works projects did very well, but the broader economy actually suffered as capital was redirected from the private sector into governmental boondoggles.

I’ll say it again: the government is utterly powerless to prevent real-estate (or any other prices) from crashing even more as we enter this deflationary cycle. Whatever spending the government does undertake will only make things worse (i.e. by siphoning money from somewhere else where it would be better deployed).

54. 54
Tim says:

I have to say that I’m a bubble believer but if they somehow get rates down to 4.5% I will start looking again. Not necessarily buy, but look.

55. 55
dailyt says:

Robert W:

Also to what extent can the US look out for help from foreign countries. For example China will be in a big predicament if US consumers retreat and don’t buy the toys they are producing. So China and many other countries would be willing to do all kinds of bailouts because this will ultimately help develop their economies.

The Chinese and their fellow BRIC countries seem to be busy cashing out of the dollar so that they can spend on infrastructure growth in their own economies. They need immediate impact for their expenditures. (Otherwise, they’ll face mass social unrest.) Take a look at the following blog from the Financial Times.

What’s everyone’s projection? Are we looking at a inflationary period which will temporarily “stabilize” housing prices? Or will the US go the way of Japan? Or worse, because the Japanese at least had the trillions of private savings and a trade surplus… while the US has trillions of debt and a gaping trade deficit.

56. 56
Sniglet says:

I have to say that I’m a bubble believer but if they somehow get rates down to 4.5% I will start looking again. Not necessarily buy, but look.

Actually, if rates get down to 4.5% you should RUN away from real estate (and virtually every other asset) as fast as possible! Low rates are a sign of deflation, and indicate that asset prices are going to keep falling. Paradoxically, a significant rise in rates (to 7%, say) would actually be a good signal that deflation was over and that prices were going to start appreciating again.

I have a podcast on exactly this subject (i.e. why low rates are something to be frightened about) at http://msurkan.podbean.com.

57. 57
patient says:

1. If you had just enough cash to buy a home now would you do it or would you wait for lower prices? If you would wait why in the world would you borrow at 4% or 4.5% to buy now? Many people still have a very warped view on debt as semi-free money.

2. If you live in Kirkland and quit your job to get a lower paying job to get loan modification I think you are fooling yourself. I highly doubt the described modifications (38% debt to income ) are or ever will be for \$500k an upwards homes. I would also be suprised if there isn’t some sort of limit on the difference in income vs debt to qualify where a big diff will be a disqualifier.

3. Whatever the gov do will likely target to stem the national foreclosure rate. The median national home is something just north of \$200k. I think King Co. home onwers will be out of luck.

58. 58
jon says:

“but if they somehow get rates down to 4.5% I will start looking again”

Calculated Risk points out that you also need to consider if you will have a buyer when it comes time to sell, and those 4.5% mortgages won’t be around for long. If too many people take advantage of that, it could be a repeat easy-money bubble.

However, because inventories are headed down and many locations are below replacement cost, I think prices will stabilize within a year or so. It may be a time to take advantage of some good deals. You just have to make sure that if you buy that it is not in a market segment that is still in over-supply.

59. 59
Sniglet says:

What’s everyone’s projection? Are we looking at a inflationary period which will temporarily “stabilize” housing prices? Or will the US go the way of Japan?

There really isn’t much of a question as to where things are headed anymore. The extremely low interest rates and crashing asset values (particularly commodities) is screaming deflation. If we were going to be headed towards inflation interest rates should be shooting up, and so should commodity prices I(in dollar terms, that is). But the exact OPPOSITE is happening.

What you have to remember is that the global private credit markets have virtually ground to a halt, and all the increases in government stimulus are just a drop in the bucket compared to the size of the credit markets that have ceased to function. When you take away 70% or 80% of the world’s money creation away (which is what the private credit markets represented in the last decade), there is no alternative but deflation.

I have a link to an excellent chart showing the historical relationship to commodity prices and the economy at http://www.surkan.com. It clearly shows that massive commodity price crashes correspond with periods of economic contraction and deflation. Scarier, this year’s crash in commodity prices is one of the most severe on record.

60. 60
Sniglet says:

those 4.5% mortgages won’t be around for long

Actually, I think that extremely low mortgage rates will last for several more years at least, and may even go BELOW 4.5%. Using my favourite example of Japan, mortgage rates have stayed at historic lows for 19 years but that hasn’t done anything to goose their real-estate market.

As I mention in my podcast, low rates are NOT an indicator of price appreciation, quite the opposite in fact.

61. 61
deejayoh says:

jon // Dec 3, 2008 at 11:51 pm

“Per Capita income is a better proxy for average salary.”

Household income is the total income of everyone living in the same unit, so it directly reflects the ability to pay the rent or mortgage on that unit. The per capita includes children, who generate no income, and so that number is not useful to understand affordability. Per capita is intended to show poverty levels because kids cost at least as much as adults when you factor in education, etc.

OK, fair enough. That is a fine clarification – but my point still stands. The claim was that homes should go back to “3x the average salary”. This will not happen because it never was the case. Even if you use HHI – which is greater than the average salary (by definition it because it includes all wage earners in home vs. a salary being for one person) that multiple at has not been 3X in KingCo for 15+ years. Using Tim’s data back to 93 shows at that point it was 3.7X and it has only gone up from there. It currently stands at about 6.4x

If you are waiting for home prices to go to 3X average salary you will be waiting for a very long time. That may have been the standard for your Grandpa – but unless he’s willing to part with his house for that amount you are out of luck.

62. 62
Another Tim says:

“YOU HAVE TO BE A REALATOR I mean that is classic — “It’s not always about the money.” — Are you serious?????”

I don’t know what a REALATOR is. If you mean realtor, no I’m not. You honestly think there’s no benefit to paying a little bit more (note I said a little, not a stupid over-inflated ridiculous price) as a premium for eventual outright ownership? Is everyone so focused on the short-term? I run into this often on a variety of subjects. Nothing over two years in the past or the future is worthy of consideration anymore.

63. 63
Sniglet says:

You honestly think there’s no benefit to paying a little bit more as a premium for eventual outright ownership?

I am sure those people who bought Tokyo suburban homes in 1994 are thrilled that they paid a premium in order to be “owners”. Those homes are STILL underwater today (by some 40% or more).

64. 64

HEY DEEJAYOH, DR ROUBINI AGREES WITH YOU ON THAT 4.5% INTEREST BAILOUT BEING A SHAM

See the proof:

http://finance.yahoo.com/tech-ticker/article/138829/Mortgage-Rates-to-4.5-Percent-Homebuilders-Win-Crisis-Continues?tickers=TOL,HOV,CTX,DHI,LEN,XHB,CTX

He asserts the 4.5% bailout helps no one except the new home builders.

Hades, practically no one in America can afford to retire on like 2-3% money markets or -40% stocks anymore; so let’s lower interest rates some more so the \$10/hr lettuce pickers can buy \$300K homes.

The American younger generation better wake up and smell the coffee; as these uncontrolled growth clowns make retirement impossible and worsen the credit crisis with more overpopulation credit crisis debt, the college graduates won’t have near as many older generation professional job slots to get hired on anymore. The older workers will just sit in their McMansions, continue working and save forever until they die or get laid off.

65. 65
Curtis says:

Ray Pepper @ 26 – Don’t worry it is a rent but no where close to a toilet tank. How do you know about living close to toilet tanks though? I hope you did’nt share your experience with us.

66. 66
what goes up must come down says:

sniglet my point exactly

67. 67
Buceri says:

The 3X rule has evolved. Sure, 25+ years ago, Household Income was, well, dad’s salary. Mom stayed home. But for the past X years has been pretty hard to buy a home on a single salary in the PS area.

Sniglet – the benefits guy from Merryl L. came to talk to us in my company. After the presentation I spoke with him about his expectations. He said; short term deflation and high inflation in 5-7 yrs (all the printing of money).

68. 68
jon says:

“Using Tim’s data back to 93 shows at that point it was 3.7X and it has only gone up from there. It currently stands at about 6.4x”

I agree with your overall point. Comparing average income to asset prices leaves out several factors. For example, it seems to me that prices are in general higher near universities (such as UW) than elsewhere, when I would expect the average income is lower in that kind of area. Part of that is because money is being pumped in from parents from other regions, but that is not income to the students. Another factor is inheritance. Boomers have a lot of siblings so it is not huge yet, but as boomers start to pass on lots of adults will be inheriting fully paid up McMansions.

69. 69
patient says:

“The 3X rule has evolved”.
It’s the new economy….
The truth is that people were much more financially conservative in the past while for decades now debt has been king. Hopefully that idea is dead and the 6x rule will vanish and devolve back to something like the 3x rule.

70. 70
jon says:

If 3x worked in an era when the husband was the only income, then in a city like Seattle where there are so many DINC households (second after only San Francisco), then 6x is the new 3x. Even if a DINC household splits up, they can relatively easily find a new partner or take on a roommate.

71. 71
patient says:

jon, if all households were dinks or roomies with equal dual incomes you would have a point. That’s not the case.

72. 72
EconE says:

Even if a DINC household splits up, they can relatively easily find a new partner…

Where? Do they go to the “partner” store? Makes divorce sound like a piece of cake!

…or take on a roommate.

If I’m in a rental that’s less than 50% of a mortgage, why would I want to pay 50% of someones mortgage to be their roommate?

73. 73
pfft says:

“”Even in light of government control of what used to be “property rights” you can still add on to the building and/or make other changes of your own desire without having to consult a landlord. It’s not always about the money.”

You are spending \$1500/month at least to paint the walls. that is the dumbest thing ever. not only do you get to spend money on improvements, you also get to lose the extra rent vs. own money on a depreciating asset. buy hey, you can open up the kitchen into the living room and paint the walls egg shell blue!

74. 74
Joel says:

The other thing that I think is a little strange is that the tax savings are “less the standard deduction”.

If you are comparing renting to buying you need to find the difference in tax savings by buying, not just the absolute savings. If a renter can deduct 10,700 already without buying, but the home buyer can deduct 20,000 then your savings by buying is 9,300 * (tax rate) not 20,000 * (tax rate).

75. 75
Other Ben says:

Joel@74

Exactly, what I’m saying is the difference will always be *at least* the interest on the mortgage payments, if the homeowner has no other major tax deductions, because of being able to deduct state income tax and property tax. If the homeowner already can take the standard deduction, if they’re a charitable giver for example, what they can deduct will be the interest on the mortgage payments *plus* the property tax, which would be even more than what I just calculated. (almost \$36k a year for the 2nd example, rather than the \$20k that tim calculated with)

76. 76
Other Ben says:

@Tim

Also, how do you get \$274 tax savings a month on a \$2500 mortgage? It looks like you calculated the first example correctly (assuming “less the standard deduction”), but not the 2nd one.

77. 77
The Tim says:

Other Ben,

Whoops, I see that I fat-fingered somewhere between my spreadsheet and the post on the second one, you’re right. That changes the monthly totals by a few hundred, but the 5 and 10-year projections were copied from the spreadsheet correctly.

As far as the interest deduction, Joel described my reasoning accurately. Also it is important to note that this “benefit” diminishes every year of the mortgage. I think it is way overplayed by those in the RE industry.

78. 78
Other Ben says:

@Tim #77

I’m confused. If a renter can already deduct 10k, and then they buy the \$550k home, they can now deduct 46k (the original 10 plus 30k for the mortgage interest plus 6k for the property tax). If they were previously taking the standard deduction, then buy the \$550k house, they were deducting 10k (for the standard deduction), and now they’re deducting 38k at least because of the mortgage interest, property tax, and sales tax.

Also, the “diminishing return” is cancelled out as well, because at the point where the diminishing becomes substantial, you start reaping in the fact that you have a fixed payment whereas rent would have risen.

79. 79
Robtr says:

There are a few misleading things about Tim’s comparison above. In Kirkland rents are averaging \$1.10 per sq. ft. You can find some for less some for more. The properties for less are pretty marginal in poor locations and in poor shape. Picking the lowest rent you can find is not being totally honest.

That being said there are also more properties for rent now because people got caught in the boom/bust and can’t sell so they are renting temprorarly at a negative cash flow until the the inventory is reduced and the market stabilizes. If you click on Tim’s link for Kirkland you will notice that the inventory is trending down and will continue to do so because very little is being built. Next year I would expect to see landlords not renewing the lease for some of these homes and putting them back on the market for sale. That means renters will be forced to move.

The last thing is the tax savings deduction. Tim’s comparison shows that the only deduction that the homeowner would have would be related to his real estate. In fact most people that can afford mortgage payments in the \$1,900 range have other deductions against their income such as student loans, capital losses, health savings accounts etc. that they would be able to also deduct by not taking the standard \$10,000 deduction. Raising the rent alone to the average price per sq. ft. raises the cost to rent from \$1,495.00 (Tim’s cost) to \$1,980.00 average cost. ad in additional tax savings, and reduce the rediculously high maintenance cost Tim has and you are paying roughly the same per month to rent as you are to own and there is no garantee that next year you can still rent in the same place at the same price. Tim also has no maintenance in his costs for renting. If you rent a home you are usually responsible for yard maintenance.

80. 80
sunsplint says:

Hi Tim,

I finally got around to reviewing this article and I wanted to thank you.
This and the spreadsheet you provided are a great help to people like me that want to explain the complexities of the market to loved ones.

Once more people start to understand the relationships between renting and buying and wages, the market will be forced to correct due to demand expectations.