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We spent some time on an airboat in the Everglades earlier this month to get a better understanding of "substitution" trends in the Seattle area apartment market. The alligators told us what we needed to know. The simplest way to think about substitution is to consider what would have happened if either of us fell out of the airboat. It's pretty clear the alligators would gladly substitute their standard diet of fish for us. Alligators will easily substitute one food source they have to work to get for an easier food source.
Alligators understand substitution. So does the apartment consumer. When monthly mortgage payments are about the same as monthly rent, it's fairly easy for consumers to substitute renting for home ownership. That's what we're facing today, and it adds risk for apartment investors.
Yes, we know there are a lot of other costs associated with home ownership. But there are benefits as well. So we will explore all of the costs and benefits in this article.
Mortgage payments are usually much higher than rent. For most of the past twenty years mortgage payments were about 40% more than rent. That means if rent was $1,000 a month, mortgage payments were at least $1,400 a month. But that's not the case today. Mortgage payments are essentially the same as rent. That's adding a lot of risk to the Seattle area apartment market right now.
The Northwest Multiple Listing Service reports the King County median sale price for detached single family houses in October was $377,500. That’s down 3.7% from $392,000 a year ago. The median price for condominiums in King County was $251,000, down 8.7% in 12 months.
According to Freddie Mac, the average interest rate for 30-year fixed rate home loans was 4.91% in early November. Using that rate, the monthly mortgage payment on the median priced house in King County today would be $1,805 if the buyer put up a 10% down payment. The median condominium would have a mortgage payment of $1,200.
The Condo mortgage versus apartment rent graph compares average apartment rent and condominium mortgage payments in King County. It shows...
November 18, 2009: I think you are partially correct, but this time financing a house is a lot more difficult. (From Seattle investor).
DSAA response:
You are correct that financing today is a lot more difficult than it was for most of this decade. But it is not more difficult than it used to be. The last few years were not the norm. Prior to that, financing was harder, like today, but there was a siginifcant mortgage premium, unlike today. That premium kept a balance between the rental and home ownership markets.
Also, don't count on financing staying as hard to get for consumers as it is right now. There is still considerable federal government motivation to "favor" homeownership. That goal can lead to loosening requirements, or providing incentives to buyers, like extending tax credits. On top of that, Congress has already passed a resolution to extend current, higher FHA loan limits through the end of next year.
Plus, the FHA is considering other changes, including: eliminating owner-occupancy requirements for condominium loans; increasing or suspending the 30% limits on condo units that have FHA mortgages; reducing or eliminating the need to sell 50% of condo units prior to FHA endorsement; and reevaluating the elimination of the Spot Loan Approval Process, where borrowers can use FHA loans to buy condos that are not FHA approved.
November 16, 2009: Thanks Mike and Patty. This is a really interesting area. I think I saw an article recently by Gary Shiller (Case Shiller Weiss) that said homeownership is really a poor choice when it comes to investment values. I've seen some similar time series calculations that support that position. (From Jack Kern, Kern Investment Research)
November 16, 2009: In talking to my tenants over the years, I've found two common misunderstandings by renters looking to purchase condos: 1) In figuring the "big tax deduction" that owning will bring, they often don't understand that the only increased tax deduction they will get is the amount over the standard deduction they already use. With the standard deduction at $11K+ for a married couple, there may be little or no increased tax deduction for interest & property tax. 2) Few renters seem to understand the risk of special assessments that are a part of condo ownership. Given the number of "leak issues" locally, the common problem of inadequate maintenance reserves in older projects, and the low-balling of initial condo dues in new projects this is a huge issue. Great subject to discuss, thanks for putting the numbers together! (from Pat Herd)
