Some purchasing based on 'consumption' reasons, not financial
By Steve Bergsman, Friday, August 13, 2010 - InmanNews
An associate of mine who analyzes the real estate investment trust market for Barclays Capital recently held a press conference, which he titled, 'U.S. Apartment Markets: Recovery Arrives.'
According to his and others' research, the multifamily housing market has finally turned the corner since the start of the economic downturn in 2007. Or, as my friend wrote, 'Apartment demand has recovered more rapidly than most observers expected.'
That's surely a relief for the owners of apartment buildings, but, tangentially, it is also good news for potential homeowners because in the shifting metrics that contrast the value of homeownership vs. renting an apartment, the forward balance is once again with owning a residence.
The pressure on apartment owners came as a bit of a surprise. When the housing market turned and people starting losing homes, it was initially assumed these former homeowners would end up renting apartments. That didn't happen.
The economic downturn was so severe that vast numbers of Americans who lost homes or jobs moved back in with family or moved in with other existing renters. They could not afford to rent an apartment on their own.
To compound the problem, so many formerly owner-occupied homes were turned into rentals that apartment owners faced a new wave of competition. The results were declining occupancies and falling rental rates.
Apparently, the bleeding has stopped in most cities and rental rates are firming up again -- except for the most severely damaged markets like Las Vegas or most of Florida.
Historically in the United States, it was always cheaper to rent than to own, but when numerous federal housing programs were introduced in the 1950s, American homeownership increased, and, according to the Wall Street Journal, by 1970 it was cheaper to buy than to rent.
The long-term appreciation of housing further imbalanced the equation. Homeownership was only around 40 percent in the United States during the 1940s, then for a 30-year period beginning in the 1960s, homeownership ranged from 60 percent to 65 percent. Coming with the new decade, a volatile combination of low interest rates, galloping appreciation and government incentives pushed the homeownership percentage to an all-time high of just under 70 percent in 2004.
Due to the tax benefit of homeownership, coupled with capital gains over the course of the last decade, at least until 2006, it was clearly less of a financial burden to own a home, said Michael Lea, the director of the Corky McMillin Center for Real Estate at San Diego State University.
'There was a strong incentive to get into homeownership, but now it is much more equalized,' Lea said.
In other words, for a couple of years renting was probably the cheaper alternative -- although it was close. However, the equation is shifting again and homeownership has become the less expensive alternative.
While average apartment rental rates have fallen over the past few years, the decline for the most part has been moderate. In comparison, home values in some places around the country have come down 30 to 40 percent. So deeper cuts in home values vs. rental costs, combined with low interest rates, make homeownership look good again, at least on paper.
Earlier this year, the John Burns Market Intelligence report declared: 'Housing cost to income ratio dropped 25 percent, and housing affordability remains excellent compared to history,' and, 'Affordability is so good that owning the median-price home is now less expensive than renting the average apartment.'
There are two problems with all of this: one is psychological and the other financial.
'This is probably a good time to buy, (as) mortgage rates are the lowest in a half century, but people are just not reacting to that,' observed Michael Carliner, an economic consultant and visiting fellow at the Harvard University Joint Center for Housing Studies.
After decades of rampant home-value appreciation, ownership decisions had as much to do with financial gain as they did about finding the perfect place for family.
Part of homeownership is having a place to live and part of it is an investment, the latter of which morphed from a long-term strategy into short-term speculation. When the prospect of capital gains went away and negative equity set in, that took a lot of wind out of the demand for homeownership.
'The cost of owning is dominated by capital gains, which if you are making a homeownership decision, means, 'What are your expectations?' ' said Carliner. 'And expectations have been tarnished by recent experience. A lot of people were overconfident about capital gains -- now they are overly pessimistic.'
A second psychological consideration to arise in this downturn is the entrapment predicament.
'One of the real negative consequences of the whole bursting of the housing bubble is that a lot of people are now locked into their house,' said Lea.
'They don't feel they can move because of negative equity. It is a real inhibitor for people who want to move to find jobs, and probably contributes to unemployment.'
The other factor in regard to buying vs. renting today is that even though mortgage rates are down, more upfront money is required and that makes buying a home costly.
As a result, Carliner offers this common-sense suggestion: If you are going to be in a location for just a year or two, the cost of buying is such a big expense that it does not make any sense to acquire; if you are going to be in a location for 10 years, you are better off buying.
Lea's son, who lives in San Francisco, was trying to decide whether he should continue to rent or to own. Lea counseled ownership, due solely to 'consumption,' not financial reasons -- and that he should factor out capital appreciation.
'So, he is going to end up paying more than he was in a rental, although he is only moving three blocks,' Lea says. 'But, he's getting a nicer place; he's in control of his own environment; monthly costs are stable; and he knows he can stay there as long as he wants.'
Steve Bergsman is a freelance writer in Arizona and author of several books. His latest book, 'After the Fall: Opportunities and Strategies for Real Estate Investing in the Coming Decade,' has been ranked as a top-selling real estate investment book for the Amazon Kindle e-reader.
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