Looking for a great buy-rent analysis tool? Go no further the the New York Times. My friend Kevin Boer blogged about it here, and I have to further endorse this product. Very cool Ajax interface and has all the things you need to understand the issues. Warning! Do not accept their base assumptions, some of which are in “Advanced Settings”, “General”. The main value to a tool like this is playing with different assumptions so that you can understand the real drivers. I have inputted some assumptions below based on a friends analysis of spending $6,850 to rent a house that might ordinarily cost him $2 million in San Francisco (yes, these are real numbers…it is that expensive here!).

Three Key Assumptions:

- Housing Value increase 4% per annum

- Rent increases 2% per annum (San Francisco is largely rent controlled)

- Investment returns of 6.5%

You can see there is no scenario that allows one to buy versus rent. So what does it take to get the buy-rent math to justify buying? Well if you increase housing prices to 5% increases per year then you get a break-even point of 7 years and if you increase it to 6% then you get a break-even point of 3 years. Although I held investment returns constant at 6.5%, prices increases for housing coincide with general returns in assets so realistically I should probably be increasing investment returns with any increase in house price appreciation . Why is this relationship so important? Because when you have money tied up in your house, that money is no longer available to invest. If you are a crappy investor no problem. If you know your way around, this makes the math even more difficult. So if I increase investment returns to match my original assumptions of 4% appreciation and 6.5% investment returns (2.5% spread), then the following buy-rent trade-off emerges:

So buying is better after 5 years but the gets worse at year 15. Why? Compounding. It seems the real issue is what is the relationship between housing returns and investment returns…something I will blog about in the future.

What was my recommendation to my friend? Rent and look for a distressed seller.

Local Resources:

San Francisco Assessor-Recorder

City of San Francisco Rent Board