While New York City rents have rebounded in the past couple of years, renting still appears to offer a better financial value than buying in the Manhattan housing market, according to a recent study by the Federal Reserve Bank of New York.
In “To Buy or Not to Buy? The Changing Relationship between Manhattan Rents and Home Prices,” author Jason Bram examines trends in residential rents and home (apartment) purchase prices in New York City’s borough of Manhattan. Focusing on the ratio of prices to rents as a way to gauge the financial value of a home purchase, Bram’s research suggests that there is less value today in a home purchase than over the past two decades.
The study begins by defining the price-rent ratio, a widely used metric to gauge home values. For an individual home, the ratio is simply the residence’s market price divided by the annual market rent it would generate. A high ratio suggests that housing prices are overvalued; a low ratio suggests the opposite. In effect, Bram notes that all the monthly costs associated with owning a home—maintenance, mortgage interest, property tax, and any owner costs including the opportunity cost of a down-payment—should not be substantially different from what one would pay in rent. To justify paying a premium to own, one would need to assume that home prices will appreciate going forward.
The study then examines trends in prices and rents over the past two decades, noting that rents tend to respond fairly quickly to economic cycles, while price movements tend to lag rents by one to two years. This pattern is consistent with the view that rents are based more on market fundamentals, while prices in part may reflect speculative and psychological factors.
Bram finds that apartment prices have increased substantially relative to rents over the past seventeen years. Although they have retreated somewhat since 2008, price ratios in Manhattan are more than twice as high as they were in the mid-1990s. Part of this increase can be explained by lower property taxes and lower mortgage rates, which tend to increase sales prices by reducing financing costs. Even so, the study finds that one would need to assume that purchase prices of apartments would appreciate by at least four percent a year to account for today’s high prices.
Jason Bram is a senior economist at the New York Fed. His study, “To Buy or Not to Buy? The Changing Relationship between Manhattan Rents and Home Prices,” can be read in full in the latest Current Issues in Economics and Finance.
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