The message in the numbers is clear: The housing market has stalled. The two most-important factors behind the slowdown are higher mortgage rates and anemic household income growth.
Still, even when the housing market slows buyers and sellers are always looking to make a deal. One way to help you decide whether to buy or to rent is to evaluate local market conditions through the lens of the price-to-rent ratio (similar to price-to-earnings ratio on stocks). The basic idea is that the rental and homeownership markets compete for your shelter money. Home prices in a geographic area are sometimes attractive compared to the cost of renting while at other times renting is the financially smarter move.
The real estate resource company HomeArea.com recently calculated the price-to-rent ratio for Minnesota cities with populations of 60,000 and more. The ratio takes the median home value and divides it by median annual rent. A ratio under 20 signals it’s likely to be more affordable to buy and a ratio over 20 favors renting. HomeArea.com found that in Maple Grove (18.2), Duluth (18.6) and St. Cloud (18.8) real estate conditions leaned in favor of buying. The ratio in St. Paul (20.1), Brooklyn Park (21.6) and Minneapolis (22.9) signaled renting was the better decision.
The ratio is only a quick first glance at value, of course. What struck me looking at the list is how high the ratio is even in cities where the real estate market leans toward buy. Home prices are high no matter where you look. The ratios are saying “buyer beware.”
That’s before taking your own personal finances into account. You don’t want to join the home hunt only to end up house poor. The longer you intend to stay in a home the better the advantages of ownership. A rough gauge is if you plan on staying in a home for less than five years renting is often preferable.
You also don’t want too much of your income going to the home. One reason why I think home sales have slowed is that people aren’t banking on pay raises beyond the 1 to 2 percent they have received in recent years. Homeownership involves many costs, including mortgage payments, property taxes, maintenance and utilities. The goal is to put 20 percent down at purchase (or close to that number).
This isn’t a brief against homeownership. Owning can make for a terrific lifestyle so long as it’s funded with a margin of safety. But the recent slowdown suggests home prices have outrun household incomes. Potential homeowners are right to be cautious.
Chris Farrell is senior economics contributor, “Marketplace,” and commentator, Minnesota Public Radio.