Leonhardt says now is a good time to buy rather than rent a home

Way back in the midst of the housing bubble's peak, David Leonhardt wrote a nice (and very influential) article about it being better to rent than buy.  His colleagues at the New York Times also put together a very nice interactive calculator that allows people to easily make their own assumptions and calculations.

Now that the bubble has deflated, Leonhardt has changed his tune. Now he says it's better to buy than rent.  At least in many parts of the country.

I am humbled to say that I was actually critical of Leonhardt when he wrote his 2005 article.  I wrote a letter to the editor of the Times, and the Times even got back to me about publishing it, but I was slow to reply since I was on vacation at the time.  My basic point was that real interest rates were low and that it seemed risk premiums were low.  Under these assumptions, basic financial calculations suggested housing prices made a fair amount of sense.  I didn't see prices rising much further, but I certainly did not see an imminent crash, as Leonhardt seemed to.

I still think my calculations made sense.  But my faith in perfectly functioning markets was way too strong.  My conception of risk was way too low.

But now that price-to-rent ratios have fallen and interest rates remain very low, it's really hard to see how buying doesn't make a lot of sense in a lot of places.  Raleigh, however, isn't one of them.  The price-to-rent ratios have increased here while they've decreased almost everywhere else.

Note that I do think one should take the Times' price-to-rent ratios with a heavy dose of salt.  These ratios are hard to measure accurately because the typical rental differs a lot from the typical home.  Making the appropriate adjustments is not trivial.  To invest well you really need to know the local market.  The transactions costs of doing that is what helps to create buying opportunities for small-time investors.

A couple things I think Leonhardt should have emphasized:  The "right" price-to-rent ratio for buying depends a lot on the interest rate and how much one expects rents to grow in the future.  If interest rates go up to 7 or 8 percent, I'd need a much lower price-to-rent ratio.  If interest rates stay low and you expects growth or inflation to increase, then even very high price-to-rent ratios make sense.  Instead of emphasizing these fundamentals, he emphasizes expectations about price increases or decreases. But that sort of gets it all backwards.