In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi examine the timeless, yet extremely timely question – to be or not to be a homeowner?
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Listen to the REconomy Podcast™ Episode 72:
“Given current dynamics, more young households may choose to rent in the near term as the cost to own, excluding house price appreciation, has unequivocally increased. Yet, accounting for house price appreciation in that cost of homeownership, whether to rent or buy will depend on where, and if, a home is likely to cost more or less in the near future.” – Mark Fleming, chief economist at First American
Odeta Kushi - Hello and welcome to episode 72 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I am Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark, let's start off the episode by discussing a recent headline, pending home sales in July increased for the second month in a row. What do you make of that?
Mark Fleming - Hi, Odeta. I would love to say that it's great news. But I am hesitant. We know that mortgage rates were lower in July than they are now, so we're not out of the proverbial woods yet. Given the historical relationship between pending and existing sales, home sales are likely to remain close to the annualized rate of roughly 4 million well into the fall. The last time we went below 4 million was actually in the depths of the Global Financial Crisis between July and October of 2010.
Odeta Kushi - Never good when you have to mention the Global Financial Crisis.
Mark Fleming - True.
Odeta Kushi - Yeah, well, you know, it's tough to have more sales without more inventory. And, while that's a bit of a downer in terms of headlines, there was a more positive headline recently -- the number of available jobs in the U.S. shrank for the third consecutive month. According to the July JOLTS data, the labor market is cooling in the right way.
Mark Fleming - It always seems strange. Bad news about the labor market, less jobs available is good news when fighting inflation. But how is this cooling the right way?
Odeta Kushi - Well, it's in the soft landing type of way. The labor market is softening. And that's being driven by falling hiring, not by rising layoffs.
Mark Fleming - Ah, yes, that's a good point. The overly high demand for labor is cooling. The Fed must be happy to hear that.
Odeta Kushi - I should think so. The Fed has been hoping for more slack in the labor market in its efforts to bring down inflation. Alright, on to today's main topic, which is not about the Fed, maybe a little bit of a breath of a sigh of relief there. What we are going to answer is Shakespeare's famous prompt, to be or not to be...a homeowner. That is the question.
Mark Fleming - As I doubt homeownership was very common in Elizabethan England, you may have taken some liberties with that quote.
Odeta Kushi - Maybe just a little bit, but can you guess what the answer to that question is?
Mark Fleming - Now of that, I am more certain. It depends.
Odeta Kushi - That's right. It depends on where you are. We recently published an analysis on our firstam.com/economics blog, discussing whether it makes more financial sense to rent or own in today's market. It's a pretty important question.
Mark Fleming - Especially when we think about the demographic shifts that are happening in today's housing market.
Odeta Kushi - That's right, the millennial generation, those born between 1981 and 1996, have recently dominated the demand side of the housing market. But Gen Z, a generation born between 1997 and 2012, is on the cusp of aging into their prime home-buying years. While potential first-time home buyers, mostly millennials and older Gen Zers, jumped on the historically low mortgage rates in 2020 and 2021, those looking to shift from renting to home buying in 2023 may not be as eager to lock into high mortgage rates that limit their purchasing power. As potential first-time home buyers consider homeownership, they're likely to weigh the cost of renting against the cost of owning a home. But how would they go about doing that?
Mark Fleming - Wait, hold on a second. Are you saying the golden age of millennials being all we talk about when it comes to homeownership demand is coming to an end?
Odeta Kushi - You know, I did like all of the attention, but indeed the end is nigh. It's time for the generation that's bringing back scrunchies, bell bottoms, glitter details and claw clips. Some of those trends should have been left behind in the '90s, but we're moving right along here.
Mark Fleming - I am still partial to the '80s, but Spice Girls?
Odeta Kushi - No doubt.
Mark Fleming - Oh, I see what you did there. Very clever. To be added to the REconomy playlist that listeners can find on Spotify. But we digress. The cost of renting is pretty straightforward. It's simply the amount of rent paid every month. Easy enough.
Odeta Kushi - That is easy enough. What about the monthly cost of owning a home?
Mark Fleming - That's where things get a little bit more complicated. The monthly cost of owning a home includes taxes, repairs, homeowners insurance, and the monthly mortgage principal and interest payments. How are we calculating the monthly cost to own in this analysis, Odeta?
Odeta Kushi - So, to calculate the monthly cost of homeownership, our analysis assumes the hypothetical first-time home buyer is taking out a 6.5% 30-year, fixed-rate mortgage with a 5% down payment on a home at the 25th percentile sale price in their market in the second quarter of 2023. You may be asking why the 25th percentile? And that's because, again, we're focusing this analysis on that first-time home buyer and first-time home buyers often buy at the lower end of the house price spectrum, as they don't have the money from the sale of an existing home to bring to the closing table.
Mark Fleming - But is that all? There's a specific benefit, or sometimes cost, that is also unique to homeownership.
Odeta Kushi - That's a good catch. Our analysis of the monthly cost to own also factors in the potential benefit of equity accumulation through house price appreciation. While high house price appreciation increases the cost to buy ,all else held equal, for the home buyer, it also provides the homeowner with the benefit of accumulating equity. Declining house price appreciation, on the other hand, results in a loss of equity and is, therefore, considered a cost for the homeowner.
Mark Fleming - And, when we calculated the cost of owning versus renting across all top 50 markets in the U.S. a year ago in 2022, we found that it was cheaper to own a home than to rent nationally and in all top 50 markets.
Odeta Kushi - Well, that's thanks to near record-low mortgage rates and the rapid house price appreciation that was occurring at the time. I assume the picture has changed a little bit since then.
Mark Fleming - Indeed, speaking of nostalgia for 2022. Substantial increases in mortgage rates, coupled with declining house prices in some markets, tipped the scale in the opposite direction. In the second quarter of this year, it was cheaper to rent than to own nationally and in 27 of the top 50 U.S. markets.
Odeta Kushi - And you mentioned it, but house price appreciation had a lot to do with that shift. Nationally, house price appreciation, according to our First American Data & Analytics House Price Index was 2% year over year in the second quarter of 2023. However, this house price growth was not uniform across markets, with some markets experiencing house price declines of up to 9%, while others experienced increases of up to 14%. As a result, the difference in the monthly cost of renting and owning varied significantly from market to market. So, when we look at that data by market, do any patterns emerge?
Mark Fleming - Indeed, they do. In many large markets, the monthly cost of homeownership far outpaced the cost of rent in the second quarter of this year. Let's take Seattle, for example. In Seattle, the median rent was approximately $1,900. And the homeownership cost was almost $7,000.
Odeta Kushi - Wow, that's a lot. In Seattle, negative house price appreciation added approximately $2,500 to the monthly cost of ownership. While this cost is not an explicit part of the homeowner’s payment to the bank every month, the decline in equity is lost down payment or homeowner equity that informs a potential first-time home buyers behavior. I mean, why buy now if it's likely to cost less in the future?
Mark Fleming - That's always the issue with deflation and, in this case, house price values declining as deflation of that particular good. You forego spending today that means that you will get a better price proverbially tomorrow.
Odeta Kushi - Now, conversely, in many Midwestern and Southern cities, such as Birmingham, Alabama and Cleveland, it was cheaper to own that rent. In Cleveland, for example, the monthly cost of rent in the second quarter of this year was just over $1,000, while the monthly cost of homeownership was approximately $1,700, before accounting for house price appreciation. But house price appreciation in Cleveland was just over 4%, making the equity-adjusted monthly homeownership cost $690 less than the monthly cost of renting.
Mark Fleming - I'm curious where Washington D.C. our home base falls on this list.
Odeta Kushi - Well, would you like to take a guess?
Mark Fleming - Let's see. It's a tough one, because D.C. has experienced slow, but steady price growth. I don't think there's been a significant decline in prices. It is a high-cost market. But there has been a lot of multifamily building, which may put some downward pressure on rents. I mean, there's so many.
Odeta Kushi - All right, all right, all right, I'll just tell you. I know you're really thinking there. D.C. fell in the cheaper to rent category, the difference between the monthly cost of renting versus homeowning was about $700.
Mark Fleming - Now, which market had the largest gap between the monthly cost to own versus the monthly cost to rent?
Odeta Kushi - I'll tell you the top three, San Jose, San Francisco and Seattle. The median rent in San Jose was nearly $3,000, while the median monthly cost to own was nearly $12,000.
Mark Fleming - That's really high. But there is one specific reason why.
Odeta Kushi - That's right. Remember that the monthly cost to own is also a function of price growth or declines. And San Jose house prices declined in the second quarter, which means that it's adding to the cost of owning that home.
Mark Fleming - Yes, good point. But let's take a step back from the monthly calculations, are there any additional benefits to being a homeowner that don't fall into this financial math?
Odeta Kushi - Certainly, research has shown that homeownership has many benefits, including wealth creation, stability, fixed payments and a longer-term benefit of generational wealth. Monthly mortgage payments that increase a homeowner's equity in their house is also a form of forced savings.
Mark Fleming - On the wealth point, as we've mentioned many times on this podcast, the 2019 survey of consumer finances found that the median homeowner has 40 times the household wealth of a renter, $255,000 for the former compared to barely $6,000 for the latter renter.
Odeta Kushi - And we know that homeowners are wealthier than renters at every income level. And the majority of homeowner wealth comes from housing for every income category, except for the very top earners. For example, for the lowest income group, the median net worth of homeowner households is just over $100,000. But, for renter households, it's only $1,500. At the lowest income category, 92% of total homeowner net worth is tied to the value of residential property. And we know that from 2016 to 2019, housing wealth was the single biggest contributor to the increase in net worth across all income groups, accounting for 32% of the overall increase. And this was especially true of lower income households.
Mark Fleming - But with all of that said, there are also so many reasons to prefer renting.
Odeta Kushi - I personally miss not having to worry about taking care of a yard. I think I rant about this quite often.
Mark Fleming - You do indeed that's certainly one of them.
Odeta Kushi - And, of course, there are risks from homeownership, and its benefits are not uniform across geographies, especially now, when prices are falling in some markets.
Mark Fleming - And, given current dynamics, more young households may choose to rent in the near term as the cost to own, excluding house price appreciation, has unequivocally increased. Yet, accounting for house price appreciation in that cost of homeownership, whether to rent or buy will depend on where, and if, a home is likely to cost more or less in the near future.
Odeta Kushi - That is correct. Well, that's it for today's episode. If you want to check out our rent versus own measure for your specific geography, you can do so on our blog. Thank you for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature on a future episode, you can email us at firstname.lastname@example.org. We love to hear from our listeners. And, as always, if you can't wait for the next episode, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.
Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2023 by First American Financial Corporation. All rights reserved.
This transcript has been edited for clarity.