It’s been hammered into people’s heads for so long that home ownership is the way to go, that potential buyers forget that’s not always the case. Especially right now, when real estate markets remain shaky in many parts of the country, the home you buy today could fall in value tomorrow.
Of course, the decision to rent versus buy boils down to many factors: how long do you plan to stay in the house? Do you have the required 20 percent down payment? Are you looking for a comfortable retirement home that won’t deplete your life savings? Do you sense housing prices will continue to fall?
To determine whether it’s more prudent to rent versus buy right now, use the “price-to-rent ratio.” Here’s how it works. Take two houses of similar size and condition—one for sale and one for rent—in the same or comparable neighborhood. Add the total cost of renting the rental property for one year. Divide the price of the home for sale by the annual cost of the rental property.
If the resulting number is between 1 and 15, it’s much less expensive to own than to rent a home. In other words, the price of the home is most likely near its low, making buying a good choice.
If the number is between 16 and 20, then buying becomes more expensive than renting (though it still might make financial sense, depending on the situation…keep reading). If the price-to-rent ratio is more than 21, the total costs of owning a home are much greater than the costs of renting. This usually signifies an overheated market where there is a chance the price of housing will fall (maybe, eventually), making renting a better option.
According to truliablog.com, in the top 10 cities for buying, the price-to-rent ratios range from 8 to 11. Note that a lot of these cities—Miami, Phoenix, Las Vegas—were hit hardest when the housing market collapsed. Subsequently, home prices had to come way down to compete with foreclosures that flooded the market.
In the top 10 cities for renting, ratios range from 33 (New York) to Dallas (19).
So where does our area fall in the rent-versus-buy equation? We looked at a selection of three-bedroom, two-bathroom homes for sale versus rent in Albemarle County. All the homes were roughly the same square footage and built on quarter-acre plots within the last 25 years. The average sale price of the homes was $299,000; the average monthly rent, around $2,400. For all comparisons, the price-to-rent ratio was between 9 and 11, which indicates sale prices are at or near their low, making buying a better option than renting in Albemarle County.
Of course, the sale price of a home doesn’t reflect the total cost of home ownership, points out Jim Duncan, Realtor at Nest Realty and blogger at realcentralVA.com. “You have to factor in all the transactional costs—Realtor’s commission, attorney fees, state transfer taxes—plus property taxes, and homeowners insurance. These aren’t costs renters have to think about.” But given that the local price-to-rent ratio is on the lower end of the spectrum (hovering between 9 and 11), even when those costs are factored in, buying may still be a better choice than renting.
So when does it make sense to rent versus buy around here? The most obvious: When you can’t afford a down payment. Renting is also smarter if you’re only planning to stay two to four years—which is not enough time to build equity or recoup the transactional costs that come with closing on a property. In other words, you’d be throwing money away.