Market conditions influence economic activity. Right now, economic uncertainty, high unemployment rates, rising real estate prices, and historically low interest rates have created a unique economic environment. While no two markets are the same, let’s see if the current market as a whole is creating more buyers or renters and how this trend can impact your investments as a real estate investor.
The case on renting
Renting a residence makes sense when housing prices are high or the supply is low. Right now, most markets are experiencing both. Home price growth in 37 of 40 major metropolitan areas that the National Association of Realtors track has seen an increase in home prices compared to last year. In addition, the average days on market is hovering around 22 days compared to 38 days last year. This is frequently used as an indicator of whether it's a buyer's or a seller's market. Increased prices and decreased days on market clearly indicate an overall seller's market, which would generally mean that it's better to rent right now.
Overall economic prosperity also plays into how many people will rent versus buy because of their financial ability to get a loan. Buying requires a substantial amount of money, unlike renting, which requires a security deposit and possibly first or last month's rent. Having a strong credit score, consistent job history, and valid income to support a home loan is necessary to get approved for a mortgage loan, especially in a tight lending market. When renting, many of these factors are considered but not underwritten as stringently. Those who have suffered from a loss of income or become unemployed from COVID-19 will have a hard time getting financing, giving preference for a renter’s market.
The case on buying
Buying a residence makes sense when rents are high. Average rental prices in the U.S. have been on the rise over the past few years, but a recent report from Apartment List found that the national rent index is down 1.4% over the past year, with several large metro markets seeing decline in demand and rental rates. Price-to-rent ratio, or the percentage consumers will pay for rent compared to the median home price, often indicates if the market as a whole is favoring renting versus buying. The higher the price-to-rent ratio, the more favorable renting is. Markets that saw large rental appreciation rates over the past few years will likely see a shift toward buying, but in balanced markets or expensive real estate markets, renting will still be favored.
Normally high real estate prices and low inventory would be enough to give preference on renting, but those who are in a positive financial situation are trying to take advantage of record low interest rates. A 30-year fixed rate mortgage is currently just above 3%, while the 15-year fixed rate is at a shockingly low 2.5%. For comparison, in 2000 the 30-year fixed rate was at 8%. Over the course of the loan, this can make hundreds of thousands of dollars' difference. If you take out a $200,000 loan for 30 years at 3%, your mortgage will cost you $303,555, with a monthly payment of $843. The same terms with an 8% interest rate ends up being a whopping total cost of $528,310, with a monthly payment of $1,468. The low interest rates are a clear incentive to buy rather than rent in most cases right now, which is motivating prepared buyers to flood the market.
Since March when the pandemic shutdowns began, rents are down in 41 of the 100 largest cities in the United States, and even the rents that have had positive growth have been minimal compared to years past. This could be a result of the temporary shelter-in-place initiatives, but it's also likely that the work-from-home trend has allowed more flexibility for people to find affordable housing options outside city centers where buying a home can often be too expensive. When looking at the lower monthly payments and overall cost of purchasing a home, buying a home is now more achievable and attractive than before. Despite high real estate prices, the low interest environment, and the flexibility for buyers to find housing in more affordable areas makes homebuying the winner.
Investors who have real estate they're interested in selling, right now could be a good time to list. Most market environments will yield top returns. Investors who own rental real estate shouldn’t panic. While some markets are experiencing more dramatic declines in occupancy and rental rates, renting won’t disappear forever. Target rental markets that have higher rent-to-price ratios and that are experiencing increase in demand, likely suburban areas outside of major metro markets. Renting will always serve a purpose in the marketplace, but right now it seems the market is favoring buyers