Buyers should jump and buy now

U.S. house prices have plunged by nearly a third since 2006, and homeownership rates are falling at the fastest pace since the Great Depression.

The good news? Two key measures now suggest it's an excellent time to buy a house, either to live in for the long term or for investment income (but not for a quick flip). First, the nation's ratio of house prices to yearly rents is nearly restored to its prebubble average. Second, when mortgage rates are taken into consideration, houses are the most affordable they have been in decades.

Two of the silliest mantras during the real-estate bubble were that a house is the best investment you will ever make and that a renter "throws money down the drain." Whether buying is a better deal than renting isn't a stagnant fact but a changing condition that depends on the relationship between prices and rents, the cost of financing and other factors.

But the math is turning in buyers' favor. Stock-oriented folks can think of a house's price/rent ratio as akin to a stock's price/earnings ratio, in that it compares the cost of an asset with the money the asset is capable of generating. For investors, a lower ratio suggests more income for the price. For prospective homeowners, a lower ratio makes owning more attractive than renting, all else equal.

Nationwide, the ratio of home prices to yearly rents is 11.3, down from 18.5 at the peak of the bubble, according to Moody's Analytics. The average from 1989 to 2003 was about 10, so valuations aren't quite back to normal.

But for most home buyers, mortgage rates are a key determinant of their total costs. Rates are so low now that houses in many markets look like bargains, even if price/rent ratios aren't hitting new lows. The 30-year mortgage rate rose to 4.12% this week from a record low of 3.94% last week, Freddie Mac said Thursday. (The rates assume 0.8% in prepaid interest, or "points.") The latest rate is still less than half the average since 1971.

As a result, house payments are more affordable than they have been in decades. The National Association of Realtors Housing Affordability Index hit 183.7 in August, near its record high in data going back to 1970. The index's historic average is roughly 120. A reading of 100 would mean that a median-income family with a 20% down payment can afford a mortgage on a median-price home. So today's buyers can afford handsome houses—but prudent ones might opt for moderate houses with skimpy payments.
For example, the median home in the greater Phoenix market, including houses, condos and co-ops, costs $121,700, according to Zillow.com. With a 20% down payment and a 4.12% mortgage rate, a buyer's monthly payment would be about $470. Rent for a comparable house would be more than $1,100 a month, according to data provided by Zillow.com.

Of course, all of this assumes mortgages are available—no given now that lending standards have tightened. But long-term data on down payments and credit scores suggest conditions are more normal than many buyers think, according to Stan Humphries, chief economist at Zillow. "If you have good credit, a job and a down payment, you can get a mortgage," Mr. Humphries says. "There's more paperwork and scrutiny than five years ago, but things are pretty much like they were in the '80s and '90s."

Not all housing markets are bargains. Mr. Humphries says Zillow has developed a new price/rent ratio that uses estimates for each individual property rather than city medians, to better reflect the choices facing typical buyers. A fresh look at the numbers suggests Detroit and Miami are plenty cheap for buyers, with price/rent ratios of 5.6 and 7.7, respectively. New York and San Francisco are more expensive, with ratios of 17.6 and 17.2, respectively. The median ratio for 169 markets is 10.7.
For investors seeking income, one back-of-the-envelope way of seeing how these numbers stack up against yields for other assets is to divide 1 by the price/rent ratio, resulting in a rent "yield." The median market's rent yield is 9.3% and Detroit's is 17.9%.

Investors would then subtract for taxes, insurance, upkeep and other expenses—costs that vary widely. But suppose total costs were 4% of the purchase price. That would still leave a 5.3% rent yield in the typical market. With the 10-year Treasury yield at 2.2% and the Standard & Poor's 500-stock index carrying a dividend yield of 2.1%, rents for residential housing in many markets look attractive.

A few caveats are in order. First, not all transactions are average ones. Even in low-priced markets, buyers should shop carefully. Second, prices could fall further. Celia Chen, a senior director at Moody's Analytics, expects prices to drop 3% before bottoming early next year and rising slowly thereafter. "If the economy slips back into recession, however, we could easily see a 10% drop," Ms. Chen says.

And property "flipping" can be dangerous even when prices are rising. That is because, absent a real-estate boom, house price gains simply aren't that exciting. Research by Yale economist Robert Shiller suggests houses more or less track the rate of inflation over long time periods.

Houses aren't the magic wealth creators they were made out to be during the bubble. But when prices are low, loans are cheap and plump investment yields are scarce, buyers should jump.

More than just real estate.

PAYBACK ON YOUR HOME REMODELING PROJECT

Dollars Invested Don't Always Add To Value


During economic downturns, home improvement stores often see increased sales as homeowners decide to improve their existing homes rather than buy new ones. Unfortunately, taking on those common home improvement projects may not return as many dollars as you hoped.

Replacing the front door of your Atlanta home may be the most cost efficient remodeling project you can make. That's according to the annual "Cost To Value" survey conducted by Remodeling Magazine in conjunction with data supplied by the National Association of Realtors. The project involves removal and replacement of both the existing door and jamb, and replacing the lock and entryset. The new door is steel clad and contains dual-pane half glass panels.

According to numbers representing the Atlanta metro real estate market, such a project would cost just under $1,150, but would add only $1,099 to your home's projected resale value. Of all the remodeling projects listed, this one was the only one that recouped close to 100 percent of its cost.

Construction cost figures include labor, material, and subtrade expenses, plus industry-standard overhead and profit, and reflect local commodity and labor costs. Resale estimates are based on responses to a poll of appraisers, agents and brokers.

The 2010-2011 edition of the report found that a typical garage-door replacement project in the Atlanta area cost around $1,245, and recouped about $1,039 - or about 83 percent - of that cost upon resale. In this case, it was specified that the motorized door opener was not replaced, but re-used.

The next two highest scoring home remodeling projects should be no surprise to Atlanta residents:

* Addition of a 16' by 20' pressure-treated wood deck with a built-in bench and planter is projected to cost about $10,500, but would recoup only about $8,018 - or only 77 percent - at time of sale. I found this to be the most surprising data of the Atlanta survey, based on my personal selling experience. I can't begin to tell you how many houses I have sold by taking prospective buyers out on the deck in nice weather and painting them a word picture of rib eye steaks sizzling on the grill. * Replacing 1,250 square feet of existing siding with new vinyl siding, including all trim, was estimated to cost around $10,948 in our area. This project was expected to return a disappointing $7,111 - about 65 percent - of the dollars it cost. * The "attic bedroom" project was specified to convert unfinished attic space to a 15-by-15 foot bedroom and a 5-by-7 foot bathroom with shower. This would include a 15-foot shed dormer, four new windows, and closet space under the eaves. The contractor would insulate and finish ceiling and walls, and carpet the floor. HVAC will be extended into the new space; electrical wiring and lighting to code.

Again, I was surprised by the poor return.

The survey estimated that this project would cost just over $50,000, which seems a speck high for this market. There are plenty of skilled home builders who are hungry for work right now, and I think you could find a good contractor who would find a way to do this job for less. Maybe I am wrong.

In any case, survey respondents estimated that this project would return only 64 percent of the dollars invested - just $32,276 - upon resale.

Particularly disappointing in this survey was a ever-popular major kitchen remodeling project. It involved updating an outmoded 200-square-foot kitchen with a functional layout of 30 linear feet of semi-custom wood cabinets, including a 3-by-5-foot island; laminate countertops; and standard double-tub stainless-steel sink with standard single-lever faucet. Included was an energy-efficient wall oven, cooktop, ventilation system, built-in microwave, dishwasher, garbage disposal, and custom lighting. This project was estimated by Atlanta remodelers to cost about $57,000, but added only about $33,400 on resale.

Copyright John Adams April 2010.