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Why rent matters
Rental prices hint at whether a housing market is riding on fundamentals or speculation.
April 7, 2005: 1:17 PM EDT
By Sarah Max, CNN/Money senior writer

SALEM, Ore. (CNN/Money) If home prices in your area are riding high and you're wondering whether it's because of dangerous speculation or a reasonable increase in demand, turn to the rental market.

In most markets, rentals prices have not risen anywhere near as fast as home prices, and in many, markets rents have fallen or remained flat.

Nationally, owning costs 7 percent more each month than renting, according to Torto Wheaton Research. The gap isn't huge but it is the widest it's been in more than a decade.

In a balanced market, say economists, the cost of renting should closely track the cost of owning. When the cost of owning is dramatically higher than the cost of renting similar property, you can guess that buyers are speculating on higher home prices.

This relationship is similar to the price-to-earnings ratio used to evaluate company stocks, said Gleb Nechayev, a senior economist with Torto Wheaton Research. In real estate, this ratio is determined by dividing the price of a house by the annual rent it could bring in given the current market.

"In some places ratios are clearly out of their historical bounds signaling slower growth in home price as interest rates rise," said Nechayev. Renting is generally more affordable than owning, he said, but the degree to which renting is more affordable in some markets "does make one wonder what's driving home prices and whether there is some speculation."

In Las Vegas and San Francisco, monthly mortgage costs on the median-priced home is nearly twice the monthly cost of renting the typical two-bedroom apartment -- and that's assuming buyers have a 20-percent down payment and finance with an interest-only loan.

In Southern California, the gap between owning and renting is also substantial, though rents there have been rising at a healthy pace.

In Atlanta and Dallas, on the other hand, it may actually cost less to own than to rent.

What gives?

Rents are a useful barometer for tracking housing markets, said David Stiff, senior economist at Fiserv Case Shiller Weiss. The trick, he said, is finding rental data that is comparable to single-family home data.

The prices tracked by Nechayev's firm, for example, are based on properties managed by large real estate firms and don't account for single-family homes and other rentals owned by individuals. (Because most rental properties in New York are individually owned, for example, the firm couldn't provide us with stats for that city.)

In some markets, Stiff added, renting may not be a realistic alternative to buying because rentals are too small or in a poor location. There are also socioeconomic-economic factors to consider. "The demand for apartments may come from a different group of people," said Stiff. "After the dot-com crash in Boston, rents started falling because unemployment rose faster among a group of people that was more inclined to rent."

In other words, don't hinge your decision to buy, sell or wait on a housing "P/E."

Still, the cost of renting should be part of your equation, said Eric Belsky, executive director of Harvard University's Joint Center for Housing Studies.

"It's good to know whether renting is a relative bargain," he said. "But you have to make the decision about whether over the long run you're better off owning or renting."

If you're planning to stay put, buying may be a better bet given that both rents and home prices are expected to go up over the long run.

If your time horizon is only a couple of years, however, your monthly savings for renting may add up to more than you'll make flipping property in an uncertain market.

Click here for more on renting versus owning.

Click here for housing forecasts for zip codes in 10 markets.

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