Monday, December 29, 2014

Renting vs. Buying

In the 2007-9 real estate boom and debacle here in Chicago there was a wave of newly built condominiums that swamped the market in River North, River East, the South and West Loop, and even Downtown. For a while the new buildings could do no wrong and then that disappeared into a pool of foreclosures and difficult times for condominium associations as they had to deal with vacant units and those that refused or were unable to pay assessments.

In the 2012-5 period, that same area of Chicago has seen an enormous influx in new buildings, but this time it is different - they all seem to be rental units. Everyone seemed to learn the same lesson; condominiums can be hard to unload in a down market and the prices are highly variable (units sold for fire-sale prices during the nadir and condominium developers lost their shirts if they were holding inventory during that time), so let's go with renters instead, who derive consistent returns for the building owner and lender.

For a bit I even thought I'd try to put my condo on the market since prices have gone up. I figured I'd just rent for a while and not be exposed to future downturns. But as I looked around for equivalent value to my current condo in terms of location, views, bedrooms and bathrooms, I noted that I'd be paying $4500+ / month for an equivalent space, if I could find it at all (inventory of larger condos in modern buildings in good walkable areas was in fact very low). That just seemed crazy.

I recently talked to a friend of mine who moved to San Francisco. She and her husband rent a two bedroom apartment in the city. The cost? $5000 / month. It is likely that their inventory selection and choices are even more limited than what's available in Chicago, to boot.

In Sunday's New York Times there is an article called "What's Up Next in New York" about renting an apartment in Brooklyn in Dumbo, which is the neighborhood right by the bridge in Brooklyn. The cost - $6018 / month.

San Francisco has some rent control laws and Chicago doesn't have any. In New York, however, there are nearly one million rent stabilized units. It is impossible to know what real values would be for apartments in NYC if at some point they deregulated the market and lots of inventory became available to new tenants.

During the 2007 high, the value of a home vs. what you could get by renting it out was completely out of whack. This all flipped the other way when property values cratered, new home building evaporated, and tougher loan rules pushed many potential home buyers out of the market. They say that today buying a home is cheaper than renting, although I don't know if that applies in the hot real estate markets in San Francisco and choice parts of NYC. There are new loan rules I see touted on real estate flyers saying "20% down loans are a thing of the past", which is meant to entice buyers who thought they were unable to purchase because they lacked a substantial down payment.

For me, the question is - who is paying $5000 / $6000 a month to rent? That seems like a lot of money - and all seem to be newer couples with at most a newborn and / or a dog. I understand the desire to avoid a hellish 1-2 hour commute each way and the fact that you don't have to spend your weekends mowing the lawn and you are near cultural amenities and all of those positive elements; but that is a very high rent to eat especially when taxes are high to boot. Conservatively you'd have to make $150,000 + a year to even think about paying those sorts of rents, and at that point you aren't saving a dime and you are just paying taxes and rent and surviving. Realistically something like $200,000 would be a more applicable family annual income to pull this off and just how many people are there that can do this? From the new developments coming onto the market, my guess is a lot. Perhaps many of these units are being rented by rich overseas students, new transplants in the city for business, or others who have access to a lot of money (perhaps inherited). Over the last decade or two the top 1% have indeed gotten fantastically rich and they have large families and for many this sort of money is just a drop in the bucket, I'd imagine.

Hopefully the rental building boom turns out better than the condominium building boom ended up. One advantage to the rental unit is that you can always reduce rent during hard times (or give a free couple of months) and you are better able to respond to market signals without permanently damaging the value of your investment. If you are selling your inventory of condos in a down turn you have no opportunity in the future to make up for the decline in values today.

Cross posted at Chicago Boyz

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