Does Rental Parity Indicate a Time to Buy?

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sonicko_IHB

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I was looking at a place yesterday that hypothetically would sell for $425 - 450k and using IrvineRenter's calculator after tax savings, lost income to down payment, etc would be about $2500. This is a 3/3 and based upon friends rental properties and what I'm seeing that seems to be the going rate on rent. Now using some buying theories you can buy when a property reaches rental parity. We're planning on staying in the area for a few years, but this isn't the last house I'll have and my fear is that this place even at rental parity may go down another 20% and that it would take more than 5 years to get my money back. Assuming this theory is correct is rental parity not the indicator to use if you're not going to stay in a house for 5 years or less at this point?
 
[quote author="sonicko" date=1231205118]I was looking at a place yesterday that hypothetically would sell for $425 - 450k and using IrvineRenter's calculator after tax savings, lost income to down payment, etc would be about $2500. This is a 3/3 and based upon friends rental properties and what I'm seeing that seems to be the going rate on rent. Now using some buying theories you can buy when a property reaches rental parity. We're planning on staying in the area for a few years, but this isn't the last house I'll have and my fear is that this place even at rental parity may go down another 20% and that it would take more than 5 years to get my money back. Assuming this theory is correct is rental parity not the indicator to use if you're not going to stay in a house for 5 years or less at this point?</blockquote>


I've been asking myself this same question. How valid of an indicator is "rental parity" if prices are still going to drop through 2009? The other important variable to keep in mind is that rental prices are also likely to drop, thus also shifting your rental parity estimate.
 
I'm already seeing prices drop for rents.



And more importantly, if you examine the really nice lease data for Irvine that IR2 posted, you will see it there too.



Personally, I would guess that rents will drop in line with expected house prices dropping (15-30% over the next 1-2 years), but wouldn't be surprised to see rents drop further/faster if unemployment rises as it looks like it will.



That is why I'm looking more to 120X GRM using a lower estimate of R
 
CM,

I have a little program that does that. I was looking at the data and realized the same thing. You'd need a GRM in the 100-130 range to be closer to the "buy it" range.

But again, that is an estimate as to when the two curves will cross... we will see.

-bix
 
[quote author="sonicko" date=1231205118]I was looking at a place yesterday that hypothetically would sell for $425 - 450k and using IrvineRenter's calculator after tax savings, lost income to down payment, etc would be about $2500. This is a 3/3 and based upon friends rental properties and what I'm seeing that seems to be the going rate on rent. Now using some buying theories you can buy when a property reaches rental parity. We're planning on staying in the area for a few years, but this isn't the last house I'll have and my fear is that this place even at rental parity may go down another 20% and that it would take more than 5 years to get my money back. Assuming this theory is correct is rental parity not the indicator to use if you're not going to stay in a house for 5 years or less at this point?</blockquote>


There's no way you lose 20% and make it back in 5 years.



Year 1: 90% (10% drop)

Year 2: 80% (11% drop)

Year 3: 80% (0% drop)

Year 4: 90% (13% gain)

Year 5: 100% (11% gain)



This doesn't make any sense. The market won't turn around so quickly (and might not drop so fast either).



Can you present a realistic scenario where a 20% drop and a recovery happens within 5 years?
 
[quote author="buylowsellhigh" date=1231273062]My thought is that REO/Auction property gives the best chance as long as you have the time/resources to repair the property.</blockquote>


Are you experienced at flipping properties?
 
[quote author="Roo" date=1231243386][quote author="sonicko" date=1231205118]I was looking at a place yesterday that hypothetically would sell for $425 - 450k and using IrvineRenter's calculator after tax savings, lost income to down payment, etc would be about $2500. This is a 3/3 and based upon friends rental properties and what I'm seeing that seems to be the going rate on rent. Now using some buying theories you can buy when a property reaches rental parity. We're planning on staying in the area for a few years, but this isn't the last house I'll have and my fear is that this place even at rental parity may go down another 20% and that it would take more than 5 years to get my money back. Assuming this theory is correct is rental parity not the indicator to use if you're not going to stay in a house for 5 years or less at this point?</blockquote>


There's no way you lose 20% and make it back in 5 years.



Year 1: 90% (10% drop)

Year 2: 80% (11% drop)

Year 3: 80% (0% drop)

Year 4: 90% (13% gain)

Year 5: 100% (11% gain)



This doesn't make any sense. The market won't turn around so quickly (and might not drop so fast either).



Can you present a realistic scenario where a 20% drop and a recovery happens within 5 years?</blockquote>


That's why I'm wondering if rental parity is necessarily the metric that I should be judging a property by or if it is only one metric. IrvineRenter has suggested that condos and townhomes may overshoot rental parity while others such as OCRenter on another blog use multiple indicators to determine a decent time to buy. In the end I see what you mean in that if I believe it will drop 20% and I'm planning on moving/upgrading in five years or so I probably shouldn't be looking to buy at this point in time. We just renewed our lease till August so we can re-evaluate then and see what the market looks like at that time.
 
Rental parity is not necessarily the bottom, although the bottom will not likely be too much lower than that. Rental parity represents the buying point where one should be indifferent between ownership and rental financially. Buying at rental parity, or any price level for that matter, assumes you will not want or need to sell for quite some time. Particularly in a declining market, it may take 5 years or more for prices to recover.



Buying at rental parity does not insure you against falling prices, but it does provide savings on one's cost of housing. People who chose to rent while prices are below rental parity, which is what happens when prices overshoot to the downside, are making a choice to pay a premium for renting to avoid the potential for continuing asset depreciation. Once prices stop falling and begin to rise, people who are paying a premium to rent will chose to buy in order to save money. This buying often gives the market momentum and brings it back to rental parity.



This is why rental parity is a fundamental valuation metric for real estate. If prices fall below this level, there is incentive to buy, and when prices rise above this level, there is incentive to rent. It is only when price momentum ignites irrational exuberance and the hope of making speculative profits that these incentives break down and prices become detached from their fundamentals.
 
All us numbers type folks want formulas and exact answers.

The re market is a market and is directed mostly by emotion which will never follow formulas or be foreseeable by the majority.

Some areas will reach rental parity.

Some areas will overshoot rental parity.

And, some will never reach parity.
 
[quote author="IrvineRenter" date=1231297581]Rental parity is not necessarily the bottom, although the bottom will not likely be too much lower than that. </blockquote>


I disagree:



The reduced population who have a downpayment and good credit, plus the exhaustion of the potential buyers (who would ordinarily wait a few years saving up a dp) during the "zero down 80/20 financing" phase should exacerbate the drop below rental parity this time through. This is not the 50% overvalue of 1990, it is a 300% overvalue.



This will lead to a more significant drop below GRM=160, and I predict it will approach GRM=100-120.
 
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