Feds Shouldn't Prop Up Home Prices

A housing report released Tuesday delivered this telling economic news: American home values in metro areas fell by 27 percent from their peak, according to the Standard & Poor's/Case-Shiller index.

The Case-Shiller index is broad, sweeping a metro area's cheapest housing markets in with its most exclusive. This can be misleading: in many cities, less expensive areas have fallen rapidly, spurring an uptick in purchases, while the priciest areas have slid less.

As the U.S. economy contracts, any sensible forecast calls for this slide to accelerate. Yet the federal government seems intent on trying to halt the normalization process, even though it would offer more affordable housing to prospective homebuyers.

The reason for this forecast is that buy-vs-rent ratios in such areas remain far higher than historic norms, a sign that localized housing bubbles have yet to deflate. The buy-vs-rent ratio is the equivalent of the price-to-earnings ratio for stocks; the Federal Reserve Bank of San Francisco uses a variant in its own analysis and noted back as far as 2005 that the "ratio is about 40 percent higher than the normal level" for San Francisco and Los Angeles. (You may have seen its cousin, the price-rent ratio.)

As of early 2009, the buy-vs-rent ratio is even further out of whack. A mile or so from my old neighborhood of Adams Morgan in Washington, D.C., you can rent a three-or-four bedroom house with off-street parking and granite counters for $4,300 a month near Calvert Street and 39th.

You can buy a three bedroom house with off-street parking and granite counters for an asking price of $1,695,000 near Calvert and 34th.

The houses aren't identical: the second includes a pool and seems larger, but let's try a rough estimate. For simplicity's sake, assume property taxes are about 1 percent, jumbo mortgage rates are 7 percent, annual insurance and maintenance costs total 1 percent, the house is bought with 0 percent down, and the buyer can deduct $21,000 a year in mortgage interest.

That means the annual out-of-pocket cost to own that size house in that neighborhood is around $148,000. Renting costs $51,600, and includes a housekeeping service. It's about three times as expensive to buy, for a buy-vs-rent ratio of 3:1.

That ratio is why, even for those well-heeled souls who could afford such a house, buying doesn't always make sense. There are some real benefits, of course, including the ability to customize your home or knock down walls. You won't be kicked out when your lease expires, and with a 30-year mortgage, you'll know how much your payments will be.

But if it's a heck of a lot cheaper to rent, why buy? For the last decade, the reason was price appreciation. When prices are falling, that's no reason at all.

Manhattanites can correct me if I'm wrong -- yes, I know each block is unique -- but consider a 4br upper east side apartment with 2,300 square feet renting for $6,000 a month. Compare that to a 4br upper east side condo with only 2,000 square feet selling for $2,775,000.

The annual totals: $72,000 to rent compared with $245,000 to buy.

Our tour continues to the posh, leafy town of Woodside, Calif., home to Steve Jobs, Larry Ellison, and local authorities who loathe new construction and adore alpaca farms.

You can rent a 3br/2ba house with a home office on Lindenbrook Road on five acres about 30 miles south of San Francisco for $4,250.

The owners helpfully provide a link to their listing when the house was on the market -- for a mere $3,299,000. An advertisement hopefully, and unsuccessfully, dubbed it a "truly one-of-a-kind opportunity."

Given the same assumptions and adjusting for local property taxes, that house would cost about $315,000 a year to buy and only $51,000 a year to rent. While it's true that you don't get to use the smaller guest house in the back if you're a tenant, you do get an 84 percent discount.

Two more examples: A 3br/2ba rental home in the hills in the tony San Francisco suburb of Burlingame costs $3,600 a month, including a gardener. A 3br/2ba house costs $1,195,000 to buy, not including a gardener. That's over $43,200 a year to rent, compared with $100,000 a year to own.

And then there's Noe Valley, one of San Francisco's most liberal and hip enclaves, at least if you're talking about the $1,000 baby stroller set. A 4br/3.5ba house on a corner lot rents for $4,500 a month. A 4br/3.5ba Noe house (that's larger but not on a corner lot) is selling for $2,495,000.

The buy-vs-rent ratio is over four-to-one: $54,000 a year to rent, compared with $231,000 for the privilege of owning a similar house a block away. As I wrote in November, the Feds should let housing prices fall. American taxpayers should not be forced to bail out underwater home-debtors concentrated in a handful of states -- the foreclosure five. (It's true that President Obama's plan announced last week is limited to lower-cost mortgages, but wait 'til the solidly Democratic coastal strongholds really feel the pain.)

One way the buy-vs-rent ratio can return to normal is for rents to rise. But a recent New York Times article about falling rents in Manhattan, and similar reports in Crain's Chicago Business and the Los Angeles Times suggests that's not terribly likely.

Perhaps the 1997 law excluding some capital gains from income taxes should shift these ratios from their long-run trend. But even taking that into account, housing prices in the nation's wealthiest enclaves still have a long way to fall -- as long as the Feds will let it happen.