As the economic recovery continues, albeit slowly and steadily, some economists are hopeful that improved employment numbers signal a forthcoming pickup in household formation, which plummeted in the wake of the 2007-09 recession as twenty-somethings returned to their old rooms or parents’ basements to wait out joblessness or underemployment. New jobs are beginning to lure those young adults out into their own homes. Simultaneously, the increased confidence in the labor and housing markets is causing existing and fortunately-independent households to considering a housing upgrade—three bedrooms, not just two, and an office too!
At the same time, currently suppressed inventory makes finding a home a battle. A question for many approaching this major change remains: is it worth it to buy? For the time being, let us set aside concerns over having the funds to close on a house, the negative equity in an existing home, or the possible weight of student debt. Let’s focus solely on this question: if you could buy, would you want to? We on the Zillow Economics team have been working hard to revise and improve the algorithm that estimates the Breakeven Horizon for every ZIP code, neighborhood, city, county and metro in the U.S. precisely to answer this question.
What is the Breakeven Horizon?
The decision to buy or rent is really a choice between a) buying a home that you hope will appreciate in value or b) renting a home, spending less on housing (at least in the early years), and saving the difference in some form that earns interest, say as stocks or bonds, instead. Options (a) and (b) each have their associated costs net of benefits. The Breakeven Horizon between renting and buying gives the number of years you would have to live in the home for the accumulating net costs of renting to exceed those of buying. In other words, after buying and living in a home for more years than indicated by the Breakeven Horizon, homeowners begin to have more money and assets than they would have if they had rented the same home over that same time period.
Breakeven Horizon across the U.S.
Nationally, the 2014 Q1 median Breakeven Horizon between renting and buying is only 2.1 years; however, there is a wide range across the U.S. The map below illustrates the Breakeven Horizon in the most populous counties. In California, Florida and some major metropolitan areas such as the Atlanta, Dallas and Detroit metros, the median Breakeven Horizon is less than two years. In comparison, most of the areas with longer Breakeven Horizons cluster in the Northeast. Select your county in the dropdown menu above the lower map to zoom in and compare the ZIP codes within the given county for a more local view. To view metro-level data, see this post.
For example, within Zillow Research’s home county (King County, Wash.), there is wide variation in Breakeven Horizons. Much of Seattle’s more urban ZIP codes sport a relatively longer horizon with Breakeven Horizons of two to four years. Southern King County ZIP codes and the up and coming ZIP codes just south of downtown, on the other hand, boast Breakeven Horizons between one and two years.
Whether less than two or between three and four years, our estimated Breakeven Horizons are shorter than conventional wisdom. So what’s happening?
The Drivers of the Breakeven Horizon
While the Buy-Rent Breakeven algorithm is detailed and comprehensive with many moving parts (see below for a brief methodological discussion), there are really only a few elements that significantly drive the results. The scatterplot below illustrates these primary relationships. The first primary driver is the price-to-rent ratio. The price-to-rent ratio measures how expensive home purchasing is relative to renting by comparing the value of a house with annual rental payments (without regard for any associated costs). The higher this value is, the longer it takes for the costs of renting to exceed the costs of buying, and so the longer the Breakeven Horizon. This relationship is illustrated by the upward slope in the scatterplot.
A second dominant driver is the expected home value appreciation. The color of the dots represents the expected appreciation rate over the first year of owning the home. The bright red corresponds to high expected appreciation, the pale red to low expected appreciation and blue to expected depreciation. As home values increase, so too does a homeowner’s equity in the home. This higher equity offsets the costs of owning a home. The faster home values appreciate, the smaller the net cost of owning in the coming years, and the sooner a homeowner will break even. Notice that for a given median price-to-rent ratio, say 18, the breakeven is longer (higher on the y-axis) for dots that are a paler shade of red or blue. Because inventories continue to be suppressed in many major markets across the U.S., we continue to expect relatively strong annual appreciation in these areas—and so shorter Breakeven Horizons.
The faster rents increase, the less time it will take for the costs of renting to exceed the costs of buying. In the scatter plot above, the size of the dots indicates how fast rents are increasing. Notice how smaller dots, associated with slower rental inflation, are more often found on the top side of the scatter cloud with longer Breakeven Horizons. Low inventory of for-sale homes also contributes to rapid rent growth. In fact, rental affordability is at a record low (the percent of monthly income spent on rent is at a record high) and further contributes to short Breakeven Horizons.
The final major drivers are not found on this scatterplot mainly because we assume them to be the same all over the country. We are referring to the mortgage rate and the alternative investment rate.
The implication of the mortgage rate is straightforward. The higher the mortgage rate, the higher the interest payments and the more costly the home purchase. The impact of the alternative investment rate is a bit more nuanced.
The Breakeven Horizon is primarily a way of comparing different combinations of something you consume—housing—and an investment good—the equity in your home or the value of other assets. The rate of return of the investment component of the home purchase is the home value appreciation. The rate of return on the investment component of renting is the interest rate earned on the extra savings. The Breakeven Horizon shrinks considerably if you save that down payment or those property taxes you avoid by renting in a simple savings account or with a CD. If, when renting, you can’t trust yourself to save the costs you avoid and instead increase your consumption of other goods and services, you’ll break even in the blink of an eye if you decide to buy. In this case, buying a home functions partially as forced savings. On the other hand, if you are a savvy investor able to earn a high rate of return on stocks and bonds, the Breakeven Horizon lengthens considerably.
Calculating the Breakeven Horizon is not as simple as adding up all the cash flowing out of your pockets in the renting scenario and comparing it to the buying scenario. To estimate the Breakeven Horizon, we consider all the costs and all the benefits associated with buying and renting.
For buying this includes a 20 percent down payment, the monthly payments on a 30-year fixed rate mortgage with an interest rate of 4.47 percent, property taxes, owner’s insurance and purchase costs (assumed to be 3 percent of home price). We also assume that as an owner, you’ll be spending 1 percent of your home’s value every year renovating and maintaining your home, and if you buy a condo, you’ll be paying an additional 1.2 percent annually (0.1 percent every month) in HOA fees. Of course for your home to approach the same liquidity as stocks and bonds, you’d have to sell it. So we also consider selling costs in the amount of 8 percent of the home’s value at the time of future sale, as well as any taxes you may have to pay on the profit from that sale. For renting, these costs include the initial deposit of one month’s rent, rental payments and renter’s insurance.
There are benefits to buying and renting as well. On the buying side we offset the costs of buying with the homebuyer’s growing equity in their home as well as federal tax deductions on mortgage interest and property taxes. Renters receive their benefit in the form of extra savings. Each month that the renter spends less out-of-pocket than the buyer, we assume she deposits this money into an account earning 5 percent annually.
Keep in mind that these costs and benefits change over time. For example, home values appreciate (for the most part) and rent increases (for the most part) every year. We assume that over the first year of owning the home, the value will appreciate according to the Zillow Home Value Index (ZHVI) Forecast of the smallest region available. Over the next five years, the appreciation rate will approach a long-term appreciation rate—the historical median annual change in home values observed in the metro during the pre-bubble years (1980 to 2000). With a forecast for next year’s rent unavailable, our expectation for the increase in next year’s rent is the average annual growth in the Zillow Rent Index (ZRI) during the four years since 2010 for the smallest region available. Over the next five years, the expected annual rental inflation will move towards the expected long-term rental inflation rate—the median annual rental inflation since 1984. The figure below gives a couple examples of our home value appreciation and rental inflation assumptions used in our analysis.
We estimate a unique Breakeven Horizon for up to 3,000 individual homes pulled randomly from each ZIP code by keeping track of home-specific costs less the benefits under both the buying and renting options as they build up over time. Where these cost schedules cross is the Breakeven Horizon. Home-specific information includes the property taxes, condo status, and of course the Zestimate and Rental Zestimate on each home. Using the Zestimate and Rental Zestimate on the same house allows us to compare apples to apples: we are able to consider the costs of buying a house against the costs of renting that same house. From this sample of Breakeven Horizons calculated for over 10 million homes, we estimate the median Breakeven Horizon for every region in the U.S. for which we report ZHVI.
 Dec. 30, 2013 national average quoted for a credit rating between 680 and 740 on Zillow Mortgage Marketplace.
 We assume utility payments are the same if renting and buying for an apples to apples comparison.
 In order to compare apples to apples, we must also assume that the buyer and renter started with the same amount of money: just enough to cover all the cash needed at the time of home purchase. To do this, we also assume that the renter must withdraw from this interest earning savings account in months where the out-of-pocket costs of renting exceed the costs of buying.
 Housing Price Index (HPI).
 CPI for Rent, Housing and Shelter.