Rent or Buy?

Due to plunging stocks and dips in national housing prices, I think I should dedicate at least a blog post to how the current economic crisis affects buying in Pittsburgh. Although it is difficult for me to recommend spending money right now, I feel that the Pittsburgh market has been relatively shielded from the rest of the country. As illustrated in my newsletter, a comparison between the US vs Pittsburgh market shows that Pittsburgh never experienced the boom of the early 90′s and 2000′s.

Recent numbers show that the Pittsburgh market is still not dropping in price. Not only has it proven itself to be historically stable,the Pittsburgh real estate market seems to be extremely stable in terms of the cost/rent ratio as mentioned by David Leonhardt.  The reason his ratio is important is because historical stability is almost meaningless in the short term (it is also rather poor at predicting the future). For example, the stock market has historically returned on average 8-10% a year since the early 1900′s. However, most investors who began investing the late 1990′s (right before the bursting the tech bubble) will find that their yearly portfolio returns are in the negatives. The moral of the story is: don’t base current assumptions on history, for history repeats itself only in hindsight, which is always 20/20. Leonhardt’s ratio is a current estimate rather than one based upon history. He compares the prices of rent and buying, assuming that the two will compete with each other if one’s prices gets too high. This allows a sort of checks and balances on buying, something prone to speculation, to renting.

Let’s look at a typical South Oakland home. I will use South Oakland as an example because I have visited many properties for rent in the area from visited friends who live there. A typical 4 bedroom housing would go for rent for about $1,000 a month, a very conservative estimate for rent. This means that over the course of 1 year, the duration of a typical lease. The total rent adds up to almost $12,000 a year. Although this seems like a lot, remember that a 3 people sharing a housing would each pay $250 for their own bedroom. For people familiar with South Oakland housing prices, very few houses that cost $1,000 a month will come close to a $150,000 asking price (let alone the sales price). Even with extremely conservative estimates, the buy/rent ratio of the home is 12.5 (150,000/12,000), below Leonhardt’s set number of 15. An important aspect of using the ratio is that it is not suited to condominiums. Due to condo fees and the fact that condo owners don’t own property, condominium are always priced lower than rent/buy would typically suggest.

Finally, I would like to end it with my favourite quote from Warren Buffett. “Be fearful when others are greedy and greedy when others are fearful.” I want to get this point across. The Pittsburgh housing market is stable enough that you should at least take a chance on it if you have enough funds. Everyone is running scared about buying, which hopefully will mean that you are buying below market value*. It is far better to put your money into a home or an IRA account than spending it on a rapidly depreciating asset (cars, HDTVs, large amounts of alcohol etc…)

*Neither Buffet nor I endorse market-timing, hence the use of hope. I believe that the buy/rent ratio reflects the intrinsic value of Pittsburgh’s real estate market. However, I make no promises.

Considering today’s election, I think it is time to look at how each candidate stands on fixing the current housing problem. The reason this segment did not appear earlier was the following. One, I did not think about it. Two, I do not think their stance on dealing with subprime housing would affect you, a student who does not own a home. However, I did think it would be interesting to see how they stand on this issue. 

Let us start first with Barack Obama. His plans to fix the housing issue can be found here. Obama’s plan is rather general. He mainly wants to focus on what he believes is the root of the current mortgage crisis, the fraudulent banks who issued the loans in the first place. For most of us, this section of the industry is known as subprime lending. He plans to fund enforcement programs to help monitor the lending industry to cut down on predatory lending. His “HOME” (Homeowner Obligation Made Explicit) score will essentially provide buyers with a simple “metric” for comparing different mortgage offers. Besides for changes to the industry, he wants to be able to modify the mortgages of Americans whose lenders fell under bankruptcy. Finally, he believes in providing a tax credit to American homeowners who make less than $50,000 a year.  

John McCain’s plans can be found here. His plan is much more definite. He plans to setup a “HOME plan” (creative isn’t it?) aimed at helping victims of predatory lending. Sub-prime mortgage owners who bought after 2005 are eligible to refinance their homes under a 30-year fixed rate plan. It does a good job of targeting buyers who are most likely to default on their home. Recent buyers would still owe a lot on their homes (consequently, they also made the least payment), making them more likely to walk away. By giving them the option of refinancing under fairer terms, McCain is trying to prevent defaults and giving sub-prime lenders a hand. 

Obama has more ideas about altering the industry. However, he doesn’t provide specific concrete steps to make it happen. Although McCain’s plans are less grand, he has simple and realistic goals to help a specific segment of the American economy.

After all the articles about renting and buying, it is finally time to talk about specific neighborhoods. The following is my personal opinion, but bear with me as I explain the logic behind it. For this week, the focus will be on locations to rent.

For graduate student renters, nothing beats the convenience of simply living in Oakland. All of the Pittsburgh graduate school resides within a couple of blocks from the Cathedral. As long as a student rents near the cathedral, it should never take more than 15 minutes to walk to class. Being closer to school means that there is no need to bring a car and worry about parking. It saves gas, time and money. Apartments in nearby areas are neither higher in quality (North Oakland has a number of high quality apartments), nor cheaper.

The only time renters should consider other locations is if they have children. The Oakland school district leaves a lot to be desired and it is better to look elsewhere. Since I am not a parent and don’t know much about the different school districts, I recommend this forum for a quick overview. Someone posted a link to a k12 website containing the following ranking:
1 Mt Lebanon
2 Upper Saint
3 Moon
4 Hampton
5 Quaker Valley
As one can see from the picture below of Mt. Lebanon on Zillow, the top school districts are also some of the most expensive neighborhoods in Pittsburgh. However, rent there is approximately the same as in Squirrel Hill. Rent goes at around $500 per person according to Craigslist.

In light of the current economic crisis, it is a good idea to look at the potential downside of buying a home. As John pointed out during the interview, buyers always have to worry about the appreciation on a home.

Appreciation is the increase in value of “something”, in this case, the “something” is a home. For the past couple of years, housing prices having risen astronomically because buyers took appreciation for granted. People began assuming that housing prices were going to go up at a certain percentage a year and immune to the ups and downs of a normal economy. This lead to widespread speculation; buyers purchase a property hoping to sell it for a profit in a few years. In cities with booming housing markets such as Miami, Las Vegas, San Diego etc… The result is this:

“The worst hit market of the 20 metro areas covered was Miami, where the median home fell a whopping 15.1 percent in value. San Diego prices also fell steeply, down 13.4 percent. Las Vegas was off 13.2 percent and Detroit by 13 percent.”

-Les Christie, CNNMoney.com staff writer

The lesson to be learned from this is that buying a home is not a fail proof investment. This is one of the reasons that I assumed no appreciation on a home in the factsheet. The Pittsburgh housing market could collapse. Although it is less likely to happen since Pittsburgh never experienced a housing boom, it is a possibility that homebuyers must face. Perhaps, most important of all, is this question: could you sleep at night knowing you owe the bank more money than your home is worth?

*It is necessary to note that speculation caused the housing crisis and only indirectly influenced the current credit crisis. The credit crisis resulted because banks began insuring the mortgage in the form of mortgage-backed securities. Then, when the housing market imploded, banks did not have enough money to pay its “insurance claims.”

This is the post that most readers are probably waiting to read. The post about the ubiquitous single-family house. One reason that I covered it last is because I want my readers to learn more about other housing choices first. It is important to recognize the other options before jumping into buying a single family home because they are anything but maintenance free.

While there are many different types of housing, the two most common choices amongst Pittsburgh graduate students are condominiums and single-family homes. This blog post will cover the main advantages and disadvantages of a condominium.

In layman’s term, a condominium is an apartment except it is bought rather than rented. A condominium buyer owns the property within the walls of his or her rooms. The rest of the building, including stairwells, elevators, lawns, roof etc…is shared by all the owners through the homeowner’s association. The homeowner’s association is responsible for maintaining the building except for each individual buyer’s rooms.

The advantages of condominiums are quite clear from the description. By having a homeowner’s association do all the work, a buyer is relieved of all usual duties of homeowners. Condominium owners do not have to worry about mowing the lawn, waiting for the plumber to unclog the sink or watch the contractor fix the roof. Due to their apartment-like nature, condominiums are generally cheaper and require less property tax.

However, the homeowner’s association is also a condominium’s greatest downfall. In order to maintain the building, the homeowner’s association charges a monthly fee. The fees typically range from $200-$700 in the condominiums I visited in North Oakland. With rent going for around $500 a person, it is easy to see why a $200+ monthly condo fee might be hard to swallow. If I spend around $400 a month just on condominium fees, I would much rather just rent. Since condos are generally small, it is difficult to get more than 1 or 2 roommates. This exacerbates the problem of having a high condo fee. Due to high fees, a buyer might end up paying the entire mortgage because a roommate might only cover the condo fee. Another problem is that part of the fees also goes towards new additions agreed upon by the homeowner’s association. Buyers could end up paying for a swimming pool when they cannot even swim.

If students can afford them, condos are great choices because they are virtually maintenance free. Therefore, the student does not have to worry about upkeep normally associated with single-family homes. There are a number of condos in North Oakland for sale within the $80,000-$100,000 range. They are conveniently located and within a 5-10 minute walk of the main Pittsburgh campus. Besides for Oakland, there a couple of small condominiums located in Shadyside at a higher price (~$130,000+). However, it is important to keep in mind that due to monthly fees, condos might cost more in the long run compared to a higher priced home. 

After using Zillow.com to get an idea of pricing around specific neighborhoods, the next step is to find some houses for sale. Here is where one can take diverging paths. The first possibility is using a real estate agent to do your search. The second is for the buyers to do their own searching. Personally, I would prefer a combination of both while going with a realtor first.

By having a realtor, a buyer can get an idea of conditions that simply are not apparent online. A realtor will often mention good places to live and provide insight into particular neighborhoods. This is extremely useful for those who do not live in Pittsburgh and understand the difference between let’s say…Bloomfield and Squirrel Hill. While an online search can quickly lead a person to find that a similar sized house is substantially cheaper in Bloomfield, the realtor can provide the reasons for this large discrepancy. Any competent realtor can tell a buyer that Squirrel Hill is a much safer neighborhood than Bloomfield, something that is difficult to find online.

After being enlightened by a realtor about the specifics of each neighborhood, it is time to look online for houses to visit. There are a number of sites available such as Howard and Hanna, Coldwell Banker, Northwood etc…Although many realtors will ask a buyer for specifications, it is often a good idea for a buyer to do his or her own search as well. Buyers should target their search to neighborhoods that are safe. One of the major reasons for this, besides the safety, is that unsafe neighborhoods have poor appreciation. Although bad neighborhoods are cheap to buy into, they do not yield much and are often difficult to sell if the situation worsens.

Once the online search begins, buyers will often be inundated with information. Not only are there tons of homes within a huge price range. There are also many different types such as, co-op, condominium, town houses, single-family homes, multi-family homes…I will cover the difference between the two main types available in Pittsburgh, condominiums and single-family homes, next week. 

Price is the main issue, a daunting one at that, which stands between a graduate student and their first home. This is not just talking about owing the bank one or two hundred thousand dollars. This is the issue of getting a home at the right price.

Most prospective buyers, me included, are worried about overpaying for their first home. The first thing to note is that homes never sell at the listing price. The listing price is the price at which every house is put up on sale. However, this is not the price buyers pay! One of the key aspects of home buying is negotiating the price. Usually, sellers will list homes at a price higher than its actual market value, hoping to get more for what it’s worth. Therefore, it is wise to get an understanding of the general market condition in each buyer’s target area (in our case, it is the Oakland, Shadyside and Squirrel Hill.) How do we do that one might ask? Clearly, most homebuyers are not professional real estate agents. Therefore, it is wise to begin the search on the internet!

Zillow is a wonderful site that literally gives its users the “edge in real estate.” By searching under an address, Zillow will actually list all past purchases on a home and give a “trend-line” for what it estimates is the current value. The website calculates the trend by analyzing the overall housing market in the surrounding area. Therefore, it does not account for recent remodeling or damages that might affect individual property value.

Although Zillow is extremely powerful in being able to provide estimates for prices on individual homes, the estimate should not be the only thing used in determining the actual value. The problem is that the “Zestimate” is an interpolation based on transactions in surrounding areas (to get an idea of the average increase in prices.) In other words, it is using the average change in market value of homes in surrounding areas to determine the true market value of any one house. It is easy to see that any particular house does not necessarily increase in value according to the overall trend. Recent changes, for better or for worse, are not reflected in the estimate.

Renting is always, and rightfully so, the first option for most student. This is mainly due to costs and the relative easy in getting out of a bad renting situation.

Nearly all rents have leases under which the proprietor states the condition and duration the renter must live. The lease can be an oral or written agreement, but for a just in case situation, I would suggest a written document if something goes wrong. It is often a good idea to read the lease carefully to see if there are any fine print items that needs to be addressed. For example, can I have a pet? Will I have to pay if the heater is damaged? The lease should be considered a legal binding agreement between the landlord and the renter. Therefore, it should be taken very seriously.

In Pittsburgh, the time duration for the majority of leases is 1 year. The advantage to this is quite clear. If renters are unhappy with their situation, they can simply move out after a year without worrying about a thing. This makes the renting situation much less stressful because unlike the buyer, the renter will not be stuck with a housing situation he/she does not like.

Another advantage, although most people will not think about it this way, is the rent itself. Rent is constant during the lease. Therefore, market situations do not affect renting as much. Renters will not ever have to deal with a housing downturn. Renters will never have to imagine owing the bank more than their house is worth.

The one-year duration also has its shortfalls. An average graduate student will go home at some point (parents can hope, right?) During the summer, graduate students will often a) go home b) stay in school or c) find opportunities elsewhere. Now, if they fall under category b, the full year lease works out. They get to keep using the apartment as they pay rent. However, in category a and b, the student is essentially paying rent for 3 month out of year while not living there at all.

The final problem, one which every Pittsburgh graduate should give some serious thought, is that the money is “gone.” In terms of investing, the annual yield for rent is -100%. When owning a home, mortgage payment eventually leads to some assets in terms of home equity, as long as the buyer does not fall behind on payments. However, homes are not fail-proof investments. They have associated costs I will discuss next week. 

For many soon-to-be Pitt graduate student, the overwhelming theme of the last few years has been getting into their dream school. But once they achieve their goal, they are left with many more questions than they started off with. Such as, where am I going to live? How am I going to pay for all this? Should I get a car? Did I make the right choice? While I won’t be here to answer all of life’s questions, this blog will hopefully help Pittsburgh graduate students make an educated choice about their housing.