A Simple Rule of Thumb On Buy v. Rent

When is a good time to get back into the housing market? A starting metric is something called the gross rent multiplier (GRM). IrvineRenter at IHB has a good discussion on this, but the intuition is fairly straightforward: you should rent or buy depending on which is cheaper.

Like IHB, I will use a GRM of 160. There is nothing magical about the number- it will be higher or lower depending on your expenses (association dues etc), but it is a fair starting value.

Here's an example of how this works: a Townhouse in South Pasadena around Marengo and Fair Oaks is being offered for $829,000. Using a GRM of 160, it means that this property, were it to be offered as a rental unit, should have a monthly rental price of $5,181.25

Is that a realistic rental price? A few blocks over, between Fremont and Huntington, a similar townhouse is being offered for rent at $2,800, at this moment in time. The locations are comparable, and the units themselves have very similar dimensions:

• Rental 1757 Sqft 3Br 2.5Ba
• For Sale 1750 Sqft 3Br 2.5Ba

Put it another way, at the prevailing rental price, the house that is up for sale should have a fair market value of $448,000, rather than the $829,000 it is asking for. Now it is entirely possible that a ton of work went into the house that is for sale, but it would be hard to imagine that $440K worth of granite counter tops were installed.

Now just because it is being offered for sale doesn't mean that it will actually be sold at that price. For example, condos in South Pasadena/Pasadena that were actually sold fetch for a significantly lower amount than $800K (although I think it is still overpriced). While the exampleI cited above involved just a few properties, this is something I see on a consistent basis. It is also an indication that that market has not fully gone out of its denial phase.