Monday, July 14, 2008

Mark Zandi says the Price-Rent ratio is returning to the fundamentally correct level

He is quoted in today's WSJ.

Also coming into balance, though not there quite yet, is the ratio of home prices to rents. The lower the ratio, the more people are likely to buy a home than rent one. Mr. Zandi estimates that this ratio dropped to 20.02 in the second quarter from a high of 24.90 during the boom. The average ratio from 1985 to 2002 was 14.44. "If you just look at affordability indices, we would say we are probably close to a bottom," says Ivy Zelman, a housing and homebuilding analyst. "But these are not normal times."


FWIW, I am in the middle of buying a house in Pasadena (when it is a done deal, I will write a little history of the transaction). It is because owning looks like a very fair deal relative to renting; also, LA is likely the place we will live for the next 20+ years, so short term house price fluctuations don't mean much to us.

5 comments:

Carlomagno said...

You don't mind your home potentially loosing 30% of its value compared to your purchase price? You must be richer than I am...

Anonymous said...

While the price to rent level is certainly dropping, the correct question to ask is whether the ratio should be the same as in the past. If you look at the chart of price to rent ratios, notice that the run-up started in 1998:

http://bigpicture.typepad.com/photos/uncategorized/2008/05/13/price_to_rent_ratio.png

While the calculation remains the same, we must ask ourselves whether anything fundamentally changed. In fact, something did fundamentally change with the tax laws. On May 7, 1997, the tax rate you pay on a primary residence dropped to 0%. This means that price appreciation in a home is of greater net present value today than it was prior to 1997. This means the price to rent ratio should be higher today than it was prior to 1997. Unfortunately, I don't know what that number should be, but it should be higher that prior to the change in the tax laws. If you wait for the price to rent ratio to get back to the old levels, it probably won't make it.

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