Rent vs. buy: Millennials take a different path to homeownership

should-you-rent-or-buyAs more millennials move up the earnings ladder, get married and start families, housing is increasingly taking center stage.

Though millennials have a higher number of college graduates than Gen Xers and Baby Boomers, they’re less likely to own a home, according to the Urban Institute. In fact, their rate of homeownership was about 8 percentage points lower than Gen Xers and baby boomers at the same age.

Among the barriers to homeownership, according to the study: delayed marriage, student debt, and choosing to live in high-cost cities. What puzzles analysts is that in many of these cities the cost of renting versus buying a home is about the same.

An analysis by CoreLogic found that the median rent and median home prices in cities with a significant millennial population didn’t show meaningful disparities. In fact, in many markets, the monthly mortgage at the current 4.5 percent interest rate was around the same amount as renting. Of course, it’s important to keep in mind that buying a house encompasses more than just monthly payments, so things like coming up with a downpayment and maintenance costs can be a barrier.

Bigger cities, bigger paychecks, bigger price tags

People who live in expensive cities tend to earn more but they also devote more of that income to housing.

One financial rule of thumb is to spend under 2.5 times your gross income on a house. That means if you or you and your spouse earn a total of $100,000 per year, you generally shouldn’t buy a house that costs more than $250,000. This could be challenging to impossible in places like San Diego and Boston.

“Your cash flow out should be no worse than what you would pay in rent. Now, if you’re paying 50 percent of your income in rent and 45 percent in a house, then I’d say looking at a house is probably worth it,” says Richard Green, director of the USC Lusk Center for Real Estate.

“Three years ago, when interest rates were lower, buying was better from a cash-flow perspective than renting was. But, now that interest rates have gone up, that’s not the case anymore.”

The up-front costs are tough for millennials

Even if you can afford monthly payments, pulling together a down payment is a problem for many young homebuyers.

In Washington, D.C., where millennials make up 35 percent of the population, programs like the Home Purchase Assistance Program, or HPAP, are popular with young singles and families, says Polly Donaldson, director of the DC Department of Housing and Community Development, or DHCD.

HPAP provides up to $80,000 in gap financing and up to $4,000 for closing costs to eligible residents. These interest-free loans don’t have to be paid back immediately.

The chart below shows the cities with highest millennial populations and median home price and rents.

Millennial Cities: Cost of Buying vs. Renting
METRO AREA PERCENTAGE OF MILLENNIALS MEDIAN HOME PRICE MEDIAN RENT
Sources: The Brookings Institution (population); CoreLogic (home and rent prices).
Washington, D.C. 35% $430,000 $2,200
Austin-Round Rock, Texas 27% $309,000 $1,700
San Diego-Carlsbad, Calif. 27% $560,000 $2,300
Urban Honolulu, Hawaii 26% $570,000 $2,100
Boston, Mass. 25% $504,000 $2,500
Houston-The Woodlands-Sugar Land, Texas 25% $240,000 $1,600
Los Angeles-Long Beach-Glendale, Calif. 25% $615,000 $3,200
Orlando-Kissimmee-Sanford, Fla. 25% $241,000 $1,600
Seattle-Bellevue-Everett, Wash. 25% $550,000 $2,600
Chicago-Naperville-Arlington Heights, Ill. 24% $250,000 $1,900
Dallas-Plano-Irving, Texas 24% $290,000 $1,800
Las Vegas-Henderson-Paradise, Nev. 24% $275,000 $1,400
Minneapolis-St. Paul-Bloomington, Minn. 24% $258,000 $2,000
New York-Jersey City-White Plains, N.Y.-N.J. 24% $465,000 $2,300
Phoenix-Mesa-Scottsdale, Pa. 24% $260,000 $1,500
San Francisco-Redwood City-South San Francisco, Calif. 24% $1,300,000 $4,500
Atlanta-Sandy Springs-Roswell, Ga. 23% 225,000 $1,600
Philadelphia, Pa. 23% $170,000 $1,600
St. Louis, Mo. 23% $160,000 $1,300
Charlotte-Concord-Gastonia, N.C. 22% $230,000 $1,500
Detroit-Dearborn-Livonia, Mich. 22% $95,000 $1,300
Miami-Miami Beach-Kendall, Fla. 22% $300,000 $2,000

Seattle, both expensive and millennial dense, is one of the highest-priced housing markets in the country. Median home prices are $550,000, so finding an affordable home is no easy feat. Although there are down-payment assistance programs, they only go so far in a place where home prices are prohibitively expensive for most homebuyers.

“The city has remained really committed to helping first-time homebuyers, but we’ve also recognized that even our down-payment assistance programs is a challenging model,” says Jennifer LaBrecque, program manager for the City of Seattle Sustainable Homeownership & Weatherization program. “We provide $55,000 in deferred down-payment loans to buy a home, but if you look at what a low-income person can afford and what a house costs, that money goes toward closing that gap but not all the way.”

The down payment is just the beginning. Buyers should also factor in property taxes, insurance, applicable association fees and repairs. The average homeowner’s insurance premium, for example, is about $1,000.

Although homeownership is alluring for a number of reasons, Green says, it’s not right for everyone. Here are some questions would-be homeowners should first ask themselves:

Where will you be in the next 5 to 10 years?

If you’re not planning on sticking around in the same house for at least five years, then you should consider renting, says Ilyce Glink, author of “100 Questions Every First-Time Home Buyer Should Ask.” This is a real estate principle known as “the 5-year rule.”

“It’s really hard to break even in less than five years, unless you buy a really ugly property, fix it up and the market is right, then you might get lucky and make money. But you can’t count on it,” says Glink.

It typically takes five years to get ahead because selling a house is expensive. Home values typically don’t increase fast enough to offset closing costs if you sell too quickly. These costs can eat away at your bottom line if you don’t have sufficient equity built up.

“In the end, buying and selling is going to be about 10 percent of the value of the house right there — it could even be more than that,” says Green.

The five-year rule is especially important for young buyers who aren’t sure if they’re going to change careers, want more space or start a family.

The opposite is true for millennials who plan to live in the same house for many years. These folks should consider buying because, over time, the house will likely appreciate in value.

“You still have to pay to live somewhere. For most Americans the biggest portion of their net worth, where their retirement cash will come from, is in their house,” says Glink. “And the way they get there is by paying down their mortgage every year, the faster the better. What they do — without even thinking about it — is they stockpile this huge amount of savings.That’s where homeownership becomes a better deal.”

Do you have an emergency fund saved?

Renting is advantageous because the fixed costs are relatively inexpensive compared to owning a house. When you rent, you don’t have to worry about costly repairs.

“You need to make sure you have some money put away if a furnace or an HVAC system dies. That could be $10,000 right there. Boom,” says Green.

“You have to ask yourself: do I have access to that kind of money? The driveway needs paving. The roof needs replacing. And even in good homes these systems wear out every 15 to 20 years.”

Homeowners who don’t have rainy-day funds run the risk of accruing debt by using credit cards or taking out loans. This could cut into  the financial benefits of owning.

Millennials have to ask themselves, says Glink, what are they willing to sacrifice to be homeowners?

“Owning a home costs money and millennials are very focused on experience. That’s eating out or traveling to everybody’s weddings or international travel. Are you prepared to give that up? Are you prepared to give up your weekly massage? Where are you willing to trade off?” says Glink.

Do you want flexibility or stability?

Your lifestyle is another factor in whether you’ll be happy as a homeowner. People who don’t want to be pinned down to one city might find homeownership a burden. It’s difficult to accept a job offer in another state when you have to sell your house first.

Conversely, people who want to live in a particular area for many years will likely find comfort in knowing they can’t be evicted by a landlord and that their monthly housing payments will remain constant.

“When I talk to millennials about renting or buying there’s an issue of timing and there’s an issue of money. And timing is everything. They have to ask themselves: ‘Am I going to be switching jobs and moving cities? Do I want that kind of flexibility? If they do want flexibility because they’re still figuring out where they want to live, then renting is a good solution,” says Glink.

~Natalie Campisi, Bankrate

Seattle’s affordability crisis is costing renters $6K per year, report says

shutterstock_89030830.0

Across the United States, renters are paying more of their income on rent than ever before, and Seattle is no exception. But what’s the actual hit to the average renter’s pocketbook like?

A new study by Zillow analyzed cost burden from renters before the housing bubble and now. Between 1985 and 2000, typical rent in the Seattle metropolitan area was about 23.8 percent of area median income (AMI). Now, it’s about 30.8 percent.

In today’s dollars, that difference accounts for $5,592 per year, Zillow’s analysis found, but that’s directly comparing median income to median rent. For homeowners, housing affordability improved, with income share spent on mortgage actually dropping a couple of points.

This would imply that the affordability gap between renters and homeowners has only grown—meaning the typical cost burden for renters could actually be a little higher than 30 percent, although the Zillow data doesn’t conclusively point to that.

It would track with data from the Harvard Joint Center for Housing Studies, which found that in 2015, nearly half of renter households in Seattle spent more than 30 percent of their income in rent, with almost a quarter of renter households spending more than half their income.

Regardless, with more than half of those filing taxes in Seattle making under $50,000, it’s safe to say that not everyone that’s paying median rent is making median income—which broke $80,000 in 2015.

Even taking the numbers at face value, though, the problem is a little worse in Seattle than nationwide. In the United States as a whole, Zillow found, the percentage of median rent to median income went from 25.8 percent to 29.1 percent, costing the typical renter around $2,000 per year.

It’s going to get Worse for Renters

We often promote homeownership over renting when a family is ready, willing and able to purchase. There are both financial and non-financial benefits to owning a home of your own. Based on the headlines below, many news outlets agreed with us after they reviewed a recent report from the Harvard Joint Center for Housing Studies and Enterprise Community Partners.

The study states that the number of households spending 50% or more of their income on rent is expected to rise by over ten percent in the next decade. They concluded:

“Overall, this white paper projects a fairly bleak picture of severe renter burdens across the US for the coming decade.”

What do other experts think of the report? You can tell by the headlines they chose to introduce their stories:

“Renters, get ready to take it on the chin” – CNBC

“The Rent Crisis Is About to Get a Lot Worse” – Bloomberg Business

“Renters Will Continue to Struggle for the Next Decade” – World Street Journal

“Why the renting crisis could be about to get a lot worse” – Fortune Magazine

“Soaring rents are a problem that will only get worse” – Business Insider

“High rents are here to stay” – The Real Deal

Bottom Line

If you are thinking about buying a home and are financially positioned to do so, now may be better than later.

Buying a Home more affordable than Renting?

Keep renting? Thinking of Buying? What’s more Affordable?

The American Dream of owning a home just got more affordable, but that’s partly because the average American now spends nearly 30% of their income on rent.

U.S. home buyers making the nation’s median income and purchasing the typical U.S. home spend around 15% of their income on their monthly house payment, excluding insurance and taxes, down from the historical norm of 22% during the pre-bubble period from 1985 to 1999, according to data released in December by housing website Zillow. On average, U.S. renters spent nearly 30% of their monthly income on rent in the third quarter of 2014, up from 25% historically. “What keeps me up at night is the fact that it still remains so difficult for so many potential buyers to make those particular stars align [being able to afford to own a home] largely because renting is so unaffordable these days,” says Zillow chief economist Stan Humphries.

This is supported by earlier studies on the subject. Renting has become significantly less affordable in recent years, according to a report released last year by the Harvard Joint Center for Housing Studies. According to that report, 50% of U.S. renters spent more than 30% of their gross income on rent (the traditional measure of affordability) in 2010, up a record 12 percentage points from the 38% of households facing such a burden a decade prior. And many of those households, about 27% of renters, spent more than half of their salary on rent, up from just 19% of renters who did so a decade ago. Landlords are hiking rents as salaries—particularly for younger Americans—remain stagnant, it found.

Nationwide, rents rose 6.1% year-over-year in November, according to separate data released by Trulia on Tuesday. Rents increased most dramatically in Denver—where the median rent for a two-bedroom apartment hovers at $1,550— a 14.2% year-over-year bump. They rose 12.2% in San Francisco ($3,600 for a two-bedroom apartment) and increased 11.9% in Oakland ($2,450 for a two-bedroom apartment). The median price of a new house sold in the U.S. hovers at $208,300, up 5% on the year in October, according to data released last month by the National Association of Realtors. Jed Kolko, chief economist at real estate website Trulia, calls this the “millennial mismatch—they can afford markets where they don’t live, but they can’t afford many of the markets where they do live.”

Millennials tend to live in areas where jobs are more plentiful, but where home ownership is less affordable. In metros with a higher population of millennial residents, homeownership tends to be less affordable for younger Americans, says Kolko. In Austin, Honolulu, New York and San Diego, 20- to 34-year-olds account for at least 23.5% of the population, putting those metros in the top 10 metro areas with millennial residents. Fewer than 30% of homes for sale in those markets are within reach of the typical millennial household. There are cheaper markets, like Oklahoma City and Baton Rouge, that have a high share of millennials, Kolko says, “but they’re the exception.”

Homeownership rates in the U.S. have steadily declined in recent years in part because millennials have delayed buying homes. Still, Humphries says it’s likely that millennials will overtake Generation X as the biggest group of U.S. home buyers, a transition aided by widespread home affordability. Population numbers may also explain the jump in buyers. There are 89 million millennials (also known as Generation Y, born roughly between 1981 and 1996) and 75 million boomers (born between 1946 and 1964) in the U.S., compared with just 49 million Gen Xers. “The allure of fixed housing payments and building wealth through home equity will draw more buyers out of rentals and into homeownership,” he says.

Quentin Fottrell