The Other Housing Bubble Casualties
Millions of Americans have been devastated by the bursting of the US housing bubble. Most of them are people who bought close to the peak of the market then lost their down payments and more when prices collapsed. Home values in the US are back to 2002 levels and people who bought near the top have lost over 30%.
The moral of the story is clear – when housing is significantly overvalued it’s better to rent than to buy.
But what about people who did the prudent thing and rented during the bubble? Did they also pay a price? And what about Canadians renting today waiting for the Canadian housing bubble to burst?
To answer that question, let’s look at an example of someone living in today’s bubbliest North American market – Vancouver. According to the latest Rental Market Report from CMHC, the average rent for a Vancouver condominium is $1,474. The average price of a Vancouver condo is $445,458.
Traditionally, real estate values are proportional to rents. The rule of thumb is that homes should cost about 15 times their annual rent. For example, a condo that rents for $1,000 per month ($12,000 per year) should sell for about $180,000. For the average condo in Vancouver, the current ratio of price to annual rent is 25.2 – implying (as did my earlier post) that Vancouver is due for a 40-50% correction.
So let’s compare two scenarios: renting during a bubble versus buying in a normal market.
Scenario 1 – Renting in today’s Vancouver condo market.
At today’s average monthly rent ($1,474), the annual cost of renting would be $17,688.
Scenario 2 – Buying that same condo if there were no bubble.
In a normal market, the average condo would be selling for 15 times annual rent – $265,320. Assuming condo fees of $3,000/year and property taxes of $1,750, the total annual cost of owning would be about $4,750/year (for the purposes of this discussion, let’s ignore mortgage costs). Additionally, an owner could expect that condo to appreciate. The long-term average inflation rate in Canada is 3.26%. Being conservative and using the average inflation rate, this condo could be expected to appreciate $8,650 during the first year.
The total benefit of buying over renting would be annual savings plus appreciation. In this case that number would be $17,688 – $4,750 + $8,650 = $21,588. For someone able to purchase that condo for $265,320 without a mortgage, this benefit would come out to 8.14%. That’s how housing bubbles hurt people who do the prudent thing and rent during a bubble. It deprives them of a tax free return of over 8%.
And in the event readers are wondering if a price to rent ratio of 15 is realistic, 98 out of 100 US housing markets now have a price to rent ratio less than 15!