Rent Or Buy In The South Bay?

To rent, or to buy: That is the question. It’s the question on a lot of minds after 3 years into the “Housing Bust.” But with mortgage rates low, prices about 20% off their 2007/2008 peaks in the Beach Cities, and with fiscal and monetary policies in overdrive trying to kick-start another housing boom, more and more people are wondering if now might make a decent time to buy. My favorite answer: It depends! I’d be making things up if I said I knew which way home prices were going over the next year; I might as well flip a coin. What I can do is crunch numbers, and that’s what everyone should be doing if they are seriously contemplating trading a lease for a mortgage.

One statistic that’s been drawing some attention this year is the National Association of Realtor’s Housing Affordability Index. The index takes into account median home values, mortgage rates, debt service expenses (including PMI), and median family income to roughly gauge housing affordability compared to the past. The gist of it is that housing is supposedly about 40% more affordable today than it was at the height of the boom in 2008:

Being a Realtor® in the South Bay, my clients want to know how this applies to the Beach Cities-Manhattan Beach, Hermosa Beach, and Redondo Beach. Since I don’t have median income data available for each year (Census data is pretty sparse), I decided to evaluate the classic rent vs. buy decision.

Rent vs. Buy. The fundamental housing decision is whether to rent, or to buy. Buying is a big deal, it comes with high upfront and recurring costs, and can lock you down to a specific property for years. Renting, on the other hand, only ties you to a location for as little as one month, or, in most cases, for up to a year with a standard lease.

Maintenance expenses can occur suddenly and can certainly take a toll on the unsuspecting home owner. It’s much easier to call your landlord to fix a leaky toilet, or roof! Renting, however, exposes tenants to volatility in housing prices; rents can, and mostly do, go up over time. Locking in a 30-year fixed rate mortgage solves that problem when you buy your home-you’ll always make the same mortgage payment.

South Bay Housing Affordability. Everyone should run through their own specific calculations when choosing between buying one home, or renting another. To keep calculations simple, and to generalize for the Beach Cities, I used Zillow’s median home values and median rental prices for each city. High transaction costs make buying a home uneconomical when holding for less than 10 years (my general rule of thumb), so I used that as a time frame to measure full ownership against rental costs.

There’s a lot of costs that go into owning a home: buying fees, mortgage interest expense, property taxes, recurring maintenance, opportunity cost of the down payment, and selling transaction fees. Most of these are straight forward, but I’m guessing most prospective buyers don’t calculate how much they’re giving up in income by putting a down payment on a home. The more you put down, the more you’re giving up in what economists call opportunity costs, income that you could have earned had you placed that money elsewhere, like a certificate of deposit (CD) with a bank.

Let’s start by considering the case where home values don’t change over the holding period. Maybe they go down, up, or zigzag, but at the end of ten years they wind up right where they started:

Buying costs consist of mortgage fees, escrow, and standard transaction services. Only the mortgage interest is calculated as an expense, since the principal, in theory, is recovered at the time of sale. Tax adjustments are made to account for the mortgage interest deduction, as is the case with property taxes. Annual maintenance was estimated as 0.75% of home value per year. I’ve seen numbers range from 0.5% all the way up to 2%, but for most people and structures these numbers usually end up on the lower end of that range. The equity opportunity cost was measured using a 5-year jumbo CD rate off of Bankrate.com.

My first inclination was to guess that the annual recurring costs would be higher when buying a home in the South Bay. Surprisingly, recurring costs are about the same for buying versus renting for all three of the Beach Cities. Here’s a summary of our results, which show the accumulated expenses over ten years for buying and renting in Manhattan Beach, Hermosa Beach, and Redondo Beach:

If home values remain exactly the same, then renting looks to have been the better choice, but not by much. Before casting final judgment, we’re going to have to go a step further to see what happens when home values fluctuate.

When is it worth buying? The obvious answer is that if home values go up enough, then buying makes sense. It turns out that South Bay homes don’t have to go up too much to make buying the better choice:

It turns out that the 20% drop off the 2007/2008 peak has almost brought prices to an equivalence point-you’d be just as financially well of buying, or renting. In Manhattan Beach that’s almost exactly the case; prices need only go up 0.2% per year, on average, over the next decade to make buying the better option. The worst case, which isn’t even bad, is Hermosa Beach, where prices would have to rise by an average annual rate of 1%.

It’s All About Risk. The difference between renting and buying is in the risk. Owning your home usually means holding a fixed rate mortgage, and never having to worry about housing costs increasing. This is especially important these days with inflation risks mounting with each new dollar the Federal Reserve creates. Owning also means you’re assuming the risk of asset value fluctuations-if home values go up, you keep all of the gain (minus the IRS take). If home values continue to plummet then you could be in a bind should you have to sell.

Renting comes with more flexibility, no potential for capital gains, and inflation risk if rents continue to increase. In the last few years those who chose to rent look like geniuses! Manhattan Beach median rental prices are down 22% over the last year, Hermosa Beach down 6%, and Redondo Beach rental rates down 7%. There’s some great deals out there to be had for tenants.

Is Housing Affordable In The South Bay? Honestly, I think it’s a coin toss at this point. At least in Manhattan Beach and Redondo Beach, home prices have dropped enough relative to rental rates to make buying a reasonable option once again. Mind you that this entire discussion is entirely based on financial considerations! There are plenty of non-financial, warm-and-fuzzy reasons to own your home. Only you can decide which way the scale should tip!

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