When should you rent versus buy? It's a question lots and lots of
people are asking these days. Armed with intriguing new post-crash data
on the relative costs of renting versus buying, TheNew York Times'David Leonhardt
suggested that the significant decline in real estate prices was making
buying a home a much better proposition in a growing number of
communities across the country. (The Times offers a great interactive rent-or-buy tool, if you're currently thinking about this).
Leonhardt's analysis provoked an intriguing debate among many of the Web's most thoughtful economics commentators. Ryan Avent, writing at Free Exchange, urged caution. Felix Salmon thinks housing prices still have a ways to fall, especially as inflation eats away at them. Robert Shiller,
the Yale economist who initially identified the housing bubble, and the
tech bubble before that, also believes real estate prices may still
have further to fall. Leonhardt replies thoughtfully here and here.
Given my ongoing interests in housing and The Great Reset, my team and I decided to take a closer look at what might be behind these patterns. The basic measure is called the housing price-to-rent ratio,
or HPR ratio. As its name implies, it is a simple ratio of the costs of
purchasing a house compared to the annual costs of renting.
Specifically, we wanted to explore to what extent HPR ratios
are associated with key economic and demographic characteristics of
U.S. cities and regions.
We based our research on the Times' analysis but developed our own larger data-set. The Times'
data, which covers 54 large metro areas, are hard to match up with the
more conventional metro definitions used by the Census and other
data-gathering organizations. So, my colleague Charlotta Mellander used
the same basic methodology to calculate our own HPR ratios for a larger
sample of metropolitan regions that we could match to a wide series of
regional indicators. Our measure of house prices is essentially the
same as the Times; it's the fourth-quarter 2009 house price series from the National Association of Realtors. Rent data is harder to come by, so we use data on 2008 median contract rent from the American Community Survey.
We feel confident that this 2008 rental data does not skew our analysis
too badly, since housing prices have fallen more dramatically than
rents over that period. Our data series covers 133 metropolitan
regions. The data sets line up fairly well. Our HPRs are, generally
speaking, slightly higher than the Times' calculations.
However, New York and Los Angeles have significantly higher HPR ratios
on our measure. This is likely a result of the way these regions are
defined in the two data-sets, since we use similar fourth-quarter data on
housing prices. Still, the two measures are closely correlated, with
a correlation of nearly .8 (.78). We also ran the same analysis on the Times' data and the magnitude and direction of the correlations are essentially the same.
With Mellander's help, we ran a series of scatter-graphs and
performed a simple correlation analysis to probe the associations
between key demographic and economic factors and the HPR ratio.
The relationship between relative costs of owning vs. renting and
housing prices is, well, striking. The line in the scatter-graph slopes
steeply upward and the fit is quite good. The correlation between the
two is a whopping .83. In simple terms, it's much more costly to own
than to rent in places where housing prices themselves are higher. In
fact, the ratio, perhaps not surprisingly, appears to be driven by
So what about homeownership? The correlation between the HPR ratio
and homeowership is negative (-.51). In other words, the costs of
owning are relatively lower in places where more people already own
their own homes. The reason is basic, actually: where housing is more
expensive, fewer people can afford to buy. Looking at the scatter-graph
above, New York, Los Angeles, San Francisco, and Seattle are all far
above the line. That is, they all have even higher HPR ratios than
their relatively low levels of homeownership would predict.
How do the relative costs of renting versus buying a home relate to
a region's economy? The short answer is that the relative cost of
owning is significantly higher in more advanced and affluent regions.
We looked at the relationship between the owning vs. renting and three
common measures of regional development -- economic output (measured as
gross metropolitan product per capita), average incomes, and average
wages. The HPR ratio is significantly associated with all three. The
correlation between the HPR and economic output is .45. The correlation
between it and average incomes is .44. And the correlation between the
HPR and average wages is .47. The HPR appears to reflect regional
The scatter-graph (above) compares the costs of owning versus
renting to regional wages. The line runs steeply upward. Los Angeles,
New York, San Francisco, Seattle, and San Diego are all above the line.
Their HPR ratios are even higher than their average wages would predict.
What about unemployment: how is it related to costs of owning versus
renting? Unemployment is generally higher in communities with higher
rates of homeownership, as I noted
earlier this week. We find that places with higher HPR ratios have
lower rates of unemployment. The HPR ratio is negatively associated
with unemployment rate, with a correlation of -.34. In other words,
unemployment is lower in places where owning costs more than renting.
Previously, we've seen how smart regions
have higher levels of income, economic output, and overall well-being.
It costs relatively more to own in smarter, more advanced regional
economies. We measure smart regions in terms of the level of human
capital; the percentage of the workforce in creative, knowledge-based,
and professional occupations; and the level of technology-based
industry. The HPR ratio is positively related to all three. The
correlation between the HPR ratio and human capital (measured as the
share of metro population with a bachelor's degree or higher) is .4.
The correlation between it and the creative class is .41. Conversely,
the HPR ratio is significantly lower in communities with a higher
percentage of traditional blue-collar, working-class jobs, with a
correlation of -.3. The HPR ratio is higher in regions with greater
concentrations of high-tech industry. Our measure of high-tech industry
is an updated version of the "tech-pole index" originally developed by the Milken Institute.
The correlation between it and the HPR is .51. The HPR is not only tied
to regional income and wealth, it is also tied to the underlying
factors that generate regional prosperity.
The scatter-graph (above) plots the HPR ratio against the percentage
of the workforce in creative class jobs. Again, New York, Los Angeles,
and San Francisco, and to a slightly lesser extent Seattle and San
Diego, are well above the line with HPRs considerably greater than
their creative class economies would suggest. The costs of owing versus
renting are significantly higher in creative class economies.
That brings us to happiness and well-being. A much-cited study by University of Pennsylvania economist Grace Wong Bucchianeri found that homeowners are no happier than renters (PDF), and also face higher levels of stress. In my earlier post,
I found homeownership to be negatively correlated with happiness
and well-being. But how does the relative cost of owning versus renting
relate to the happiness and well-being of communities? Happiness, we
find, is greater in regions with higher HPR ratios. The correlation
between the two is .47. That is, people are happier in places where it
is more expensive to buy than to rent.
What to make of all of this: where exactly should you buy, and where
should you rent? Leonhardt suggests that it's worth buying when the
ratio is 20 or less. Dean Baker sets the threshold somewhat lower: He says it makes sense to consider buying when the ratio is 15 or less.
From where I sit, the picture looks a bit more complicated. It boils
down into two distinct questions. The ratio of owning versus renting
provides a good handle on the first of these. It enables you to
objectively compare the ongoing costs of owning versus renting your
home. But it is not as good on the second question. Avent zeros in on
this when he says that housing is a "highly leveraged, undiversified,
relatively illiquid bet, with a return that is highly correlated to local labor
This second question is about economic context. Is the house located
in a growing economy, one where its value is likely to go up, and where
you can sell it if you need to? Looked at this way, it may be that
places with higher relative costs of owning versus renting are the
better bet. Consider that the places with the "best" relative cost of
owning are older Rustbelt cities like Detroit, Pittsburgh, and
Cleveland, and Sunbelt cities of sand like Phoenix, Las Vegas, and
Tampa. But, the ones with the "worst" are high-tech centers like
Silicon Valley, Seattle, and Boulder, places with lots of natural
amenities, or on our measure the big super-star cities of New York and
Here's what David Albouy, a University of Michigan economist who has done detailed studies (PDF) of the factors that determine regional housing prices, has to say:
If prices reflect the present discounted value of future
rents, then a low price-to-rent ratio today suggests that future rents
will be low, probably because local amenities or job opportunities will
be less desirable. Financially, you're putting a bet on a place that
now looks like a loser, but more importantly you're making it harder to
move out of a place where the prospects don't look so good. The other
thing is that homeownership may be over-rated socially. It eats up
tremendous time and money. Talented people may benefit themselves and
society more by providing or developing products for the larger public,
rather than devoting their time to amateur home-improvement (although
some fix up houses pretty nicely).
In the end, the costs of owning are relatively higher in communities
with higher levels of economic output, higher incomes, and higher wages
-- that is where there is higher effective demand. They are also places
with among the lowest levels of homeownership and where there is likely
a relatively large pool of people who would like to be able to buy a
house there someday. Not to mention they are the places with stronger
underlying economic prospects -- witnessed in their higher levels of
human capital and more high-tech and creative economic structures. They
are the places that, generally speaking, are attracting skilled
people, generating new technologies and industries, which provide
the greatest economic opportunity.
If I had to bet on real estate I'd bet on just these kinds of
places. (It's what I did, actually: I bought in D.C. and Toronto, but
chose to rent in Pittsburgh and Miami). And my hunch is the high cost
of owning a home as opposed to renting in these places -- like their
higher housing prices to begin with -- reflects just that.
Next up: I take a detailed look at the newly released Case-Shiller Home Price Index.