By BRETT ARENDS
My wife and I recently sold our condo in Miami Beach to buy another one. The one we sold was a studio -- or "junior one bedroom" -- in a historic art deco building, a short walk from Ocean Drive and the popular News Cafe. It fetched $95,000.
Was that cheap? Expensive? People offer all sorts of conflicting opinions about any real estate move -- especially right now, and especially in a shattered market like Miami. But the answer is surprisingly easy to find.
We didn't want to be landlords, but we had credible offers to rent our studio for $1,100 a month, or $13,200 a year. (A few years ago, we would have only gotten about $900 a month). Deduct $5,000 a year for taxes and condo fees and maybe $1,000 for other costs, and that leaves about $7,000 in profit. That's a net rental yield of 7.4 percent on our buyer's purchase price. In an era when 10-year Treasury bonds pay 2 percent and a 30-year mortgage may cost just 4 percent, it ain't hay. Ultimately, it seems our buyers got a good deal, and nationwide, many other people could be doing equally well.
Two-thirds of U.S. families own a home, says the Federal Reserve, and their home typically accounts for two-thirds of their assets. Residential investment is also a major driver of the economy. And yet for all this importance, so many people focus on the wrong things. They ask when the market will bottom out. They fret about the "shadow inventory" of unsold foreclosures. They steer clear of cratered markets like Phoenix or Las Vegas until they see a "return of confidence," but they jump into New York or San Francisco's sky-high prices without a second thought.
Real estate is a simple asset to understand. If you buy a home, you can live in it without paying rent, or you can rent it out to someone else. It has no other use. It has no other value. Rent is to housing as earnings are to stocks. The only sensible way to approach real estate is to compare the price with present and future rents. That's it.
Time to Buy?
Some real estate economists say that when home prices are 15 times annual rents or lower, it makes more sense to buy than to rent. That's now the case in about three-quarters of American cities. Some of the price-to-rent ratios:
- 6: Las Vegas
- 8: Sacramento
- 10: San Antonio
- 13: Miami
- 15: Chicago
- 24: San Francisco
- 36: New York
In early 2008, I first visited Miami to report on the housing bubble for The Wall Street Journal. I checked out some of the brand-new superluxury high-rises downtown, overlooking Biscayne Bay. Prices had already plunged. But, as I calculated, renting one of these places still cost only half as much per month as owning one.
Dean Baker, economist at the Center for Economic and Policy Research, offers a simple rule of thumb. "Based on a historical examination of the price-to-rent ratios," he says, home prices are close to fair value when they are about 15 times gross annual rents. By this measure, Baker says, some of the hardest-hit markets -- such as Detroit and Phoenix -- are now very cheap, and places like Washington, Boston and San Francisco look expensive.
Home prices are down a third from their 2006 peak, according to the Standard & Poor's/Case-Shiller 20-city housing index. From the gloomy way people talk about the housing market, you'd think rents were falling too. They're not. According to the Department of Labor, rents have been rising steadily for years, aside from a brief lull in 2009 and 2010. They rose 2.5 percent nationwide last year, to a new high.
Naturally, the economics of all this will vary from property to property. From my own admittedly anecdotal experience, you seem to get the highest rental yields from the smallest properties in the best locations (like a studio a short walk from Ocean Drive).
Trulia, the online real estate company, estimated in a report last summer that it was cheaper to buy than to rent in three-quarters of all major U.S. cities. Average prices were just six times rents in Las Vegas. Meanwhile, prices were 36 times rents in New York and 24 times in San Francisco. Good luck with that.
If you live in a place where prices are cheap compared with rents and if it fits your circumstances, buying a home now is a compelling financial move. It's a smart investment because it offsets a hidden liability: You will always need somewhere to live. If you don't buy, you will need to find rent money every year, and rents have historically risen -- and will likely continue to rise -- at least in line with inflation.
It's incongruous that while investors have been bidding up the price of inflation-protected Treasury bonds to crazy heights, they have been shunning real estate. A home is also, in a sense, an inflation-protected bond, with rents as the coupon. Very long-term studies of real estate have typically found -- depending on the data -- that house prices have either tracked inflation or beaten it by one or two percentage points a year.
If you're shopping for a home, don't ask the real estate broker what's happening to prices locally. Ask what's happening to rents. That should tell you most of what you need to know.