Darleen, I am sure you will find this article interesting.
economist.com
>>America's housing bubble continues to inflate. Although the rate of increase slowed in the fourth quarter, prices were still up by 11.2% over the year. In California and Washington, DC, housing prices rose by more than 20%. Alan Greenspan, the Fed's chairman, recently admitted in congressional testimony that there may be property bubbles in “certain areas” and a risk that prices could decline. There is certainly evidence that prices are being driven by speculative demand: a new study by the National Association of Realtors shows that one-quarter of all houses bought in 2004 were for investment, not owner-occupation.
The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier. To bring the ratio of prices to rents back to equilibrium, either rents must rise sharply or prices must fall. Yet central banks cannot allow rents to surge as this would feed into inflation. Rents directly or indirectly account for 29% of America's consumer-price index, so rising inflation would force the Fed to raise interest rates more swiftly, which could trigger a fall in house prices. Alternatively, if rents continue to rise at their current annual pace of 2.5%, house prices would need to remain flat for over ten years to bring America's ratio of house prices to rents back to its long-term norm. There is a clear risk prices might fall.
The unusual divergence between house prices and rents does not just affect investors; it also undermines the conventional wisdom that it is always better to buy a house, because “rent is money down the drain”. Today in many countries it is much cheaper to rent than to buy.
The figures look even more striking in the San Francisco Bay Area, where it is possible to rent an $800,000 house for $2,000 a month. Making the same assumptions about rents and house prices, but also deducting tax relief on a fixed-rate mortgage and adding property taxes, a buyer would pay $120,000 more over seven years than if he had rented. House prices in San Francisco would need to rise by at least 4% a year (2% in real terms) for it to prove cheaper to buy a house. Since 1950 American house prices in real terms have risen by an annual average of just over 1%. To expect them to rise faster from their current dizzy heights smacks of irrational exuberance, to say the least.<<
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