May 19, 2013

Rent vs. Buy: How Homebuyers Calculate & Decide

May 19, 2013

Rent vs. Buy: How Homebuyers Calculate & Decide

Yesterday The Economist updated it’s quarterly global home price tables to show where homes are over/under valued relative to rents and income. Local pricing is quite different from national pricing, but this Economist update is still relevant because it reiterates how consumers should evaluate a home purchase.


…To gauge whether homes are cheap or expensive we use two measures, both of which compare current estimates with a long-run average (in most countries, going back to 1975). This average is our benchmark for “fair value”.

…One is the ratio of prices to disposable income per person, a measure of affordability. The other is the price-to-rent ratio, which is analogous to the price-to-earnings ratio used for equities, with rents going to landlords (or saved by homeowners) equivalent to corporate profits. If these gauges are higher than their historical averages, property is overvalued; if they are lower, it is undervalued.

Of these two Economist metrics, the price-to-rent ratio is more important for homebuyers to understand what they’re getting into.

But first comes another ratio: a deb-to-income ratio measures total housing cost (plus all other debt) against income to determine whether a you can afford a home. All U.S. lenders qualify borrowers using this ratio.

The first link below explains how you determine how much home you can afford (debt-to-income ratio), and whether it’s cheaper to rent or buy (price-to-rent) in your local market.

The trick with rent vs. buy is that you need truly local market data do analyze it correctly.

To do so, you can’t look at the table above for home prices—though doing so is encouraging since it shows the U.S. as a whole is undervalued. Your local market isn’t necessarily the same, especially if you live in an area where home prices have been rising faster than rents.

So the second link below explains how to drill down to street-level home pricing in your local area.

How To Calculate Rent vs. Buy Correctly

How To Price A Home Locally (Hint: ignore Case Shiller data)

For my local readers: Bay Area Home Price Maps (May 2013)

The Economist’s May 2013 Global Home Price Roundup