Rent, or Buy?

The early 2000s . . . ah yes, the good old days, when home prices were soaring and investors were flipping houses and making money hand over fist. And then, the total collapse . . .

With today’s economy in a state of flux and the real estate market still flat-lining, thousands of wonderful homes are sitting on the market. Homeowners are under water on their mortgages and can’t sell, and are becoming landlords by default.

People are nervous. The banks, who were so crazily free-wheeling a few years back, have tightened the purse strings to the point where applicants who deserve loans are being denied. Even those who are capable of purchasing homes are hesitant:

  • They’re unsure of the direction of the economy
  • They fear being laid off.
  • With the rising cost of education, they’re choosing to put money in their children’s college funds rather than invest in “The American Dream.”

But for those who still lust after that traditional dream, there’s a formula — although a loose one at that — that might help determine if your city is one in which it’s better to rent or buy. It’s called the rental ratio formula and here’s how it works.

You take the cost of the house you’re looking to buy, and find out what the comparable place would cost to rent, for one year. Divide the total yearly rent by the sale price of the home. If the asnwer is less than 15, it makes sense to buy rather than rent.

For example, on the three-bedroom foreclosure I purchased last fall (See “And Speaking of Fortunes Being Made . . .”, October 2010) the rent I receive is $825/month x 12 = 9900. In this Indianapolis market, I bought that home for 35K and with repairs, have a total of 40K in it. But, the surrounding homes are worth (in a normal market) 80K. Either way, when I do the equation, the results are 4 and 8.5, meaning Indy is definitely a city where it’s better to buy.

But don’t be fooled by the numbers or the gurus. Even though this formula says it’s more costly to rent than buy, our Indy rental market is very strong and I don’t see the end in sight. My 27 rental units never stand empty, which tells me there’s opportunity on both ends — both as a buyer, if you can qualify, pay cash or use private money — and as a landlord who rents out your properties.

So don’t be shy . . . now’s the time to buy!

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