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Here's my single data point in Toronto. My wife and I bought a house last year just before our (first) baby was born. It's in Little Italy, a central and very desirable neighbourhood of old homes. We had been renting a 3 bedroom apartment (in an old Victorian house divided into apartments)and we bought a 3 bedroom house in the same neighbourhood. Our house has a basement apartment which we rent out. We put down a 5% down payment on the $500K cost of the house and got a 25 year amortization variable rate mortgage (prime - 0.9%...which seems pretty sweet based on what's available now). Our rent was $2100, and we paid utilities on top of that for a total of about $2300. Our current mortgage payment is $2800 (including property taxes). Utilities are about $300/month, for a total of $3100. We get $700/month in rent so we're out of pocket $2400, which is only $100 more than what we were paying in rent.

The fact that those numbers are close suggests to me that house prices aren't terribly out of whack with rents. With the house, we're building up equity but if we'd rented, the $25000 down payment would have grown. The thing that these type of analysis always seem to miss is that there are non-financial motivations to owning a home. We wanted to be able to renovate to our taste which you wouldn't do in a rental unit. We wanted a feeling of permanence and ownership of the home where we'd be raising our children, something that isn't a factor if you're single or childless.

Interestingly enough, our mortgage payment has fallen by about $500 in the last year due to interest rate cuts. At the same time, my sense of the local RE market is that house prices have fallen. You certainly see houses on the market for longer and various anecdotal info points to falling prices (as well as recent official reports). Significantly higher interest rates would certainly make buying look much more pricey than renting, at least for us.

Even single data points are useful, I think, to check on the plausibility of the analysis. Four (offsetting) omissions from your calculations though:
1. Maintenance costs on your house. $5,000 per year?
2. Higher insurance costs of owning vs renting. $1,000 per year?
2. The foregone interest on your downpayment. 3%? x $25,000 = $750 per year?
(Those add to the costs of owning)
4. Inflation. Your mortgage debt is declining in real terms due to inflation, over and above any principal you pay down. Alternatively, your rent would be rising in nominal terms if you hadn't bought the house. 2% x $500,000 = $10,000 per year
(That subtracts from the cost of owning, or adds to the cost of renting.)
These four omissions probably cancel out, approximately.

The subjective stuff is important for many people, but hard to measure. Being able to fix up and change my house and garden is important to me too. But I wonder how important it is to the marginal buyer (the one who is just indifferent between buying and renting)?

Nick, this paper on the Decomposition of Rent-Price Ratio from the Federal Reserve Board, suggests to me that the long term decline in the rent-price ratio is primarily a decline in the housing premia. If expected future returns are lower than historical returns, then it supports your position the UBC paper should not be using past returns in the equilibrium model.

There are too many formulae in the paper for me but I did note that San Francisco had a rent-price ratio of 2.8% in 2005. FWIW, I think Vancouver with a 3.6% ratio in 2008 is in real trouble but Ottawa is not.

Interesting paper you link to marmico. I think your conclusion is right. One thing though is that property taxes do seem to vary a lot between cities. If property taxes (as a percentage of house price) are 2% in city A and 3% in city B, then we should expect the rent/price ratio to be one percentage point lower in A than in B. Maybe San Francisco (like Vancouver) has low property taxes (as a percent of house prices)?

travis: since I don't 100% trust values based on rent, it is good to look at other measures too. But looking at house prices compared to CPI, or compared to income, seems to have greater problems. If the average house is getting bigger, or better, the average house price should rise relative to CPI. The Case-Shiller index attempts to adjust for this by looking at price changes for the same house over time, but even then I'm not sure if it takes account of extensions or other home improvements, or just looks at the street address. (Does anyone know?) In any case, if technological improvement in house construction is less than the average for the economy (and it looks that way to my untrained eye), we would expect real house prices to rise over time, just like haircuts. And looking at house prices compared to (household?) income implicitly assumes a unitary income elasticity of demand for housing. Maybe richer people want to spend a higher proportion of their permanent income on housing? Yet a third way would be a "Tobin's Q" measure: to compare house prices to the cost of building a new house. But then much of the value of a house is the value of the lot on which it sits, and you can't build new lots.

Coming at this question from a different angle, and for use in an unrelated excercise - i've estimated an econometric supply/demand model for real home prices in BC that suggests that homes in BC, on average, should fall about 16% in real terms. I'd guess that the price adjustment in Greater Vancouver would be higher than the average for BC, though by how much I couldn't say.

A slightly different look at a related exercise - a question an associate was looking at a couple of years ago in T.O. How long does one have to own the house before it makes sense to buy? In this instance, this was a recent immmigrant who located there after completing their MBA in Canada - and was uncertain about long term prospects.

So, if you were to also factor in the costs of purchasing and selling a house (realtor, legal fees etc - say 5% to 7% of the purchase/selling price) it would seem to me that you would only get an average positive return after about two years of ownership - perhaps a caveat for flippers/restless/unsettled types.

Or are these costs buried in the analysis somewhere that I missed?

Home prices fall by most in 26 years.


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