The Mortgage Mess: Part 2 Rent or Buy...

We don't want to be homeless, so we need to figure out where to live next. Have any advice or insights to add to my analysis? We know a lot of homeowners, so if we're missing something you'll have to set us straight as we try to figure things out.

Option 1: Rent

We could just find another place to rent. Taking a look at craigslist there are places available in Mountain House and Livermore. We could also look at Tracy, CA the next town to the east and live next door to MC Hammer but Tracy smells like cow poo.

It is off-season for finding rentals, but with the number of foreclosures displacing people it is likely the rental market supply will continue to shrink. The homes available for rent comparable to what we're in now seem to be a couple hundred dollars more each month than what we're paying. Plus we have the expense of hiring movers and commitment to a one year lease to consider. We've been month-to-month since last August.

One problem I have with rents is it is unclear whether the rent increase is due to increased mortgage expenses as rates reset or due to increased demand. I have been trying to track the number of listings on craigslist to see how quickly they are being scooped up. There are at least two rentals that have been available for the past 10 days.

Option 2: Buy

We are pretty confident we're not going to be in California for 30 years, but we still may be here long enough to justify buying a place. In Mountain House and towns farther east real estate has dropped hundreds of thousands in the past year and a half. Livermore and the Bay Area have softened some but are not yet affordable with a traditional mortgage. We are not far from Stockton where 1 in 6 homes is vacant and considered the epicenter of the foreclosure crisis. Is there opportunity here?

The $600k home I mentioned in the last post was ridiculous and didn't make sense. I dug up some numbers to try to figure out what was going on.

Historical Pricing Trends

Based on data from the US Census Bureau there is median house prices collected since 1940, both nationally and by state. In 1940 the median price in California was $3527, in 1950 it was $9564, and by 2000 $211,500. The best decade, 1970 - 1980 saw a 13% increase in house value year over year, and the worst decade 1980-1990 saw an average increase of less than 1% per year. Overall from 1940 through 2000 the average was around 7% per year housing appreciation in California. If you project that out to 2008, the median price of a house in California would be around $365,050.

Income-to-Home Ratio

Ok, what about income trends. I only found California data for 1990 ($33k) and 2000 ($47k). With those median household income values, we find the median price of a house being 4.5 - 5.5 times income. With the most recent data I've seen (2006) for our area, the median household income is around $75k. That projects to a house valued around $375k.

Affordable for Income

Based on income above, a traditional loan would recommend you spend no more than 30% of income on housing. Based on rates at 5.75% that projects out to an affordable home for the area to be around $330k not counting property taxes or homeowners into the equation as 40% seems generally common practice.

So, based on that data I'd expect half the homes to be priced under $350k. They're still not there yet.

Market Conditions

In Mountain House as of 01/08/2008 there were 87 active homes for sale with 7 pending sales and 2 homes sold in the last 30 days. Pulling data from trulia it looks like there were 12 homes sold in Mountain House in January ranging in price from $340k to $665k. Looking at MLS data there are 160 3+ bedroom, 2+ bathroom homes for sale in the 95391 area code. In just Mountain House as of Feb 9 there are 79 homes for sale with a high at $819k and a low of $299k and median asking price of $445k.

The economic fortunetellers are predicting home price declines potentially for the next few years. Back in October Goldman Sachs did an analysis where they concluded:

"Our house price model indicates that Californian homes are 35-40% above the price range implied by current and forecast economic conditions... economic conditions support prices between $350-$380k; material price declines are likely, in our view."

Rent vs. Buy

Given the current rental and selling conditions, is it worth it for us to buy? I put together a spreadsheet long ago that has evolved into a little python script for performing a price sensitivity analysis to figure out when to buy.

Let's take a $300,000 house as an example and make some assumptions for down payment (20%), income tax (25%), property tax (1.25%), and insurance (1%). The mortgage payment would be $1400 for a total monthly cost of $1963 with taxes and insurance.

After one year:

• remaining principal: $236,912
• home equity growth: $3,087
• tax benefit: $4,573
• property taxes: $3,750
• homeowners insurance: $3,000

If we took one of the rentals at $1750 and an investment savings rate of around 4% we would increase our savings by $1,876 in interest alone for the year and put $4,433 more in savings by avoiding property taxes and homeowners insurance.

In a flat market on that $300k house, rent would need to go up to $1845 to make the costs of homeownership balance the benefit. Then it would require a 6% commission or $18k to get out of the home. That means the house would need to appreciate at least 1% a year, or 5% overall to make up the cost of selling if we were to leave in 5 years.

This model is simple and does not account for maintenance costs and I think long term appreciation in home value beyond 1% a year is reasonable -- though that was the case throughout the 1980's as mentioned above. Buying would lock in the cost of rent that could continue to rise. Anything else I'm missing?

We went to take a look at some foreclosures last weekend so I'll talk more about that in the next post.

If you made this far -- enjoy Hammer time: