Vacancy rate data from the Federal Reserve Bank (the Fed) gives some indication of price pressure in the rental and home buying markets. High vacancy rates will put downward pressure on prices.

Should You Buy or Rent Your Home?

Buying is risky. So is renting. Figure 5 compares them.

Although home ownership used to be the cornerstone of the American dream, it seems now like changes in demographics, housing economics, real incomes, debt burdens, and interest rates have called into question this conventional wisdom. Technology, in particular, has been changing consumer expectations as more people eschew material ownership in favor of sharing economy approaches.

But this doesn’t seem to apply (yet) to housing. Actual rates of home ownership in the United States have remained fairly consistent for decades. The US Census Bureau reports that the rate of home ownership stood at 63% in 1963, peaked at 69.2% in 2004, and has since come back down to 64.3% in 2018. So, despite innovation in mortgage markets, lending practices, securitization of mortgage derivatives, and incentive programs for first-time buyers, overall rates of home ownership have barely budged over the last five decades.

Still, the Housing Market Crisis of 2007–2008 was so disruptive, and so expensive to many people who bought houses near the peak, that many people who once took home ownership are asking themselves, “Should I buy or rent?”

The Federal Reserve Bank of St. Louis republishes data on home prices in an index called the S&P/Case-Shiller Home Price Index, and it shows that prices have fully recovered from the 2008 Great Recession. And then some.

Figure 1: S&P/Case Shiller National Home Price data is republished by the Federal Reserve Bank (used here only for non-commercial, educational purposes under Fair Use). It shows that home prices now exceed their 2007 Housing Bubble peak.

On average the American housing market has been on a robust, upward price trajectory for nearly a decade — but not in all cities. This is same index, but only for home prices in the Phoenix metropolitan statistical area.

Figure 2. Phoenix metropolitan area data shows that the bubble was bigger here, and that prices haven’t yet recovered.

It shows that prices climbed faster in Phoenix leading up to the peak, fell further, and have yet to get back up to where they were.

It’s an interesting story, but it does little to answer the question, “Buy or rent?” for residents of Phoenix, or anywhere else, because people do not pay cash for homes. They make monthly payments that include interest and principal on a mortgage loan, private mortgage insurance, property taxes, home owner’s insurance, association fees (if any), and then they have additional expenses like utilities, maintenance, and realtor fees.

Typical analyses of “Buy or rent?” draw attention to the difference in who pays what expenses, such as maintenance, taxes, utilities, mortgage principal, and interest. What these analyses fail to realize is that these expenses, normally associated with home ownership, must be built into rent as well. That is landlords expect to be able to pay all of the expenses they are responsible for from the proceeds of the rent they collect.

The differences in the way that owners and renters pay for housing creates a data problem for the Federal Reserve as they attempt to track housing costs (not home prices). For this reason, the Fed invented another statistic called Owner’s Equivalent Rent and it is meant to wrap up all the costs of home ownership into a single measure that is valid whether your own or buy your home. It includes expenses like debt and taxes.

For Phoenix, it looks like this:

Figure 3. The Owners Equivalent Rent is an estimate of housing costs published by federal Reserve that includes additional factors (e.g., interest, taxes) that are not included in home prices. It is a broader measure of housing costs than the S&P?Case Shiller index, and the data the Fed uses to calculate the housing component of the Consumer Price Index often used to measure inflation.

When you compare Owner’s Equivalent Rent to the S&P/Case Shiller home price index for Phoenix, one thing that jumps out at you is that the Fed’s estimate of equivalent rents is up way past the 2007 peak, even though home prices have not returned to those high levels. If mortgage rates were higher now than in 2007, then the difference between rent (i.e., housing costs) and home prices might be due the increased interest expense.

It is not.

Figure 4. 30-yr mortgage interest rates are well below their 2007 levels, but rising fast.

In fact, mortgage rates now are much lower than they were at the price peak of early 2007. One of the reasons that home prices recovered from their Great Recession lows is the fact that lower mortgage rates made new homes more affordable for buyers.

The real cause of the difference between the rent and price graphs are temporary market imbalances and distortions… what we might call a bubble.

Looking at the left edge of each graph, we can see that the run up in home prices from 2002–2007 was not accompanied by increases in the Owner’s Equivalent Rent. Both indices started at about 100 after the dot-com stock market bubble burst in 2001, but the home price index peaked at over 220 while the rent index only got up to 115 or so.

In other words, 2007 in Phoenix was a really good time to rent and a crappy time to buy.

It’s easier to compare the two on a single graph, so I’ve taken the home price index and divided it by the equivalent rent index.

Figure 5. The ratio of the S&P/Case Shiller Home Price index and the Owener’s Equivalent Rent index for the Phoenix metropolitan area shows when rental markets offer better value to consumers than buying markets do. A low ratio suggests that renting is the better option. Right now, the two markets are roughly in balance with one another.

The volatility in the index over the last 15 years is extraordinary. When the ratio is low, the market favors renting. When it is high it favors buying.

The rapid decline between 2004–2006 corresponds to the runup in home prices (while rents barely budged). The peak in the ratio corresponds to the collapse in home prices, and an increase in renters resulting from mortgage foreclosures.

The data in this graph could have prevented a lot of home buying mistakes in Phoenix during 2004–2006 if people had rented instead. The irony is that the best time to rent looks to most people like the best time to buy, because home prices are going up to fast, and people are afraid that if they wait, they’ll lose out on an opportunity to buy the home they want, or speculate on home price appreciation.


Aside from the convenience of being able to remodel, redecorate (for home owners) or not having to worry about surprise repair expenses (for renters), the principal financial difference in the decision to rent or buy depends on three things (in declining order):

  1. Changes in the market value of the home,
  2. The creditworthiness of the buyer/renter, as expressed in terms of the interest rate at which they can borrow funds (i.e, obtain a mortgage),
  3. The frequency of transaction costs, such as real estate commissions, and
  4. The relative strength of the rental and home price markets.

The home price/rent ratio figure speaks directly to this last point, about the relative strength of the two markets. However, by far the most important and the most uncertain of these factors is the expected change in the market value of the home.

To establish the current market value of any particular home, professional appraisers typically look for comparable homes that have sold recently. Using a database of home sales available from the Multiple Listing Service (MLS), appraisers will establish the value of an uncertain property by comparing it to those of similar size, condition, and locations, making adjustments for inevitable dissimilarities. Because only licensed professionals have access to the MLS data, buyers, renters, landlords or home owners doing their own research must rely on alternative sites such as zillow.com or realtor.com, which glean sales data from public records and provide updated estimates or home value. Because these estimates are not informed by an inspection of the property in its current condition, they are often understood to be less reliable than a professional appraisal or a real estate market analysis. Nonetheless, they are widely available.

Home owners take all of the risk of declining home prices, and all of the gain of increasing. Moreover, except in the case of adjustable rate mortgages (ARMs), homeowners enjoy certainty in fixed mortgage principal and interest payments. Only their taxes and maintenance expenses can go up. By contrast, renters may be subject to price increases when market conditions result in low vacancy rates.

Thus, the decision to Buy vs Rent will depend on the net present value of the expected future cash flow forecasts. Home owners should forecast constant payments for several years, with only modest increases for taxes or home owners association fees, while renters might use the data from the Owner’s Equivalent Rent figure to forecast slowly increasing rents. At purchase, a homeowner may incur large one-time transactions fees and pay a down payment, whereas a renter will only be required to post a security deposit (and sometimes the first and last month of rent). At the end of the ownership or rental period, the homeowner will sell the property and have the proceeds of the sales, less any transaction fees (such as a real estate commission, typically 5%-7% of the sale price) and the payment of the remaining mortgage principal. Thus, the homeowner might recover cash from the sale, or have to pay additional cash if their sale price is insufficient to fund payment of the remaining mortgage principal. By contrast, the rent typically expects only return of their security deposit, with no market risk from the sale and fewer transactions costs.

The best way to answer the Buy vs Rent question is to draw the expected cash flow diagrams for each alternative, compute the net present value, and then conduct a sensitivity analysis that explores different eventual sale prices. The alternative with the least net present cost (or value) will be the preferred option… but, the answer is likely to depend entirely on the final sales prices. Those buyers optimistic about market appreciation will have a preference for buying, while pessimistic buyers will prefer to rent.

For most people, that’s too much work, and too much math.

Fortunately, the ratio of home price to equivalent rent indexes in Figure 5 provides an easy warning of when housing markets are overheated, and buyers would be well advised to rent instead.

This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.