This Is Why I Rent: Median Incomes Do Not Support Median Home Prices
Sep 17, 2007 -- When you rent, most people mistakenly assume the decision is made out of necessity, not rationality. But there is a very good reason to rent in today's bubble-stricken market: median incomes do not support median home prices.
By Ben W. (bdarbs)
Median income household cannot buy median priced home
The graph above demonstrates three very important facts.
* Whenever prices rise more than the normal trend, they eventually correct and drop back in line.
* This housing bubble is an absolute giant when compared to the housing bubbles of the previous decades.
* Income levels haven't come close to keeping up with home price inflation. For decades, home prices strongly correlated with median incomes. In 1997, everything changed.
What does this mean?
Now is perhaps the best time in US history to be a renter. You are far better off paying high rents for the next few years than buying a home and watching your equity disappear while the market takes a freefall.
Not convinced? Here's my argument...
The home prices that we are seeing today are artificial and not sustainable. This is because home prices have deviated from the fundamental formula that has always ruled the real estate market. Nationally, median home prices increased by nearly 50 percent in the last decade. The median income, on the other hand, has gone up 10 percent in the last ten years--a very meager increase compared to the change in home prices.
Incomes simply cannot support the bubble-inflated prices. In many places, Americans earning the median income have no chance of reasonably affording a median priced home with a conventional home loan.
Of course, many borrowers didn't take out conventional financing during the last 5 boom years to purchase their home. Instead, they got caught up in the housing frenzy and took out ultra-risky, exotic subprime mortgages just to get into the market. The result has been mass foreclosures and a complete meltdown of the lending industry. Now with over 156 major U.S. lenders imploded since late 2006 (source: ml-implode.com), lending institutions have tightened their lending standards and drastically cut the pool of bona fide buyers.This is a national problem, not just a local one
A major correction is inevitable. Of course, optimists like to argue that the correction will not be national, but will instead be limited to the most overpriced areas. While it is true that the most overpriced cities are likely to see the largest declines in prices, containing the carnage would take a miracle.
According to John R. Talbott, a UCLA scholar and former investment banker, 22 of the most overpriced cities represent nearly 50 percent of the value of residential real estate in the United States. If prices go down in these cities only, the effect will still be felt nationwide. Contributing to the nationwide housing decline are the nearly one million jobs lost since the housing downturn began. This accelerated employment decline is occurring everywhere, not just the largest cities.
The correction has already began
People are missing their mortgage payments, banks are foreclosing, and prices are already starting to drop.
In many places such as Florida, Northern California, and Southern California, home prices have already started a long and painful freefall. The extent to which prices will fall is debatable, but if history has taught us anything, we can expect to see prices come down to pre-boom (1997) levels. This means price corrections in the magnitude of 25 to 50 percent in many areas of the country.
Imagine buying a $250,000 house now, only to see it fall in value to $125,000 within the next five years!Don't listen to the Realtor sale speak
The National Association of Realtors, the self proclaimed 'Voice of Real Estate', is still insisting that real estate is a good long-term investment. This statement is not only ridiculous, it is irresponsible and irrational. Any way you do the math, buying real estate at the beginning of a massive housing downturn is a terrible investment.
Think about it. Homes are usually purchased with 80 to 100 percent debt. Let's say you are a diligent saver and make a 20% down payment on a $500,000 home. If home prices go down only 20 percent, you will lose 100 percent of your investment and your equity will be completely wiped out. What if prices go down by 30%? In this case you will not only lose your $100,000 down payment, but you will be underwater in your mortgage by $50,000.
Even stock market investments aren't that risky. At no time in history (and this includes the great crash of 1929) have investors lost 100 percent of their net worth. But this is exactly what will happen to the majority of the homeowners in the U.S. that buy during this market collapse.My advice
Save your money. Rent a home you are comfortable living in for a few years and you will be able to buy a lot more house once the market ends its freefall and the dust settles.