With Ken Johnson, Real Estate Economist at Florida Atlantic University
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Ken Johnson, Real Estate Economist at Florida Atlantic University, had a lot to say about housing trends, specifically the availability of good deals in 2019.
The Market Is Good
Pointing to the current Palm Beach County housing market and the linear track of historic pricing trends, Johnson pointed to the market currently sitting above the pricing trend by just under 20 percent, leaving many investors to continue buying property in an attempt to lock in prices before they get too high. Johnson added the percentage was at 66 percent back in 2006, just before the housing market crashed.
Owning And Renting For Wealth
On the question of renting or owning in terms of wealth creation, Johnson noted the considerations for owning (cost of ownership, mortgage payment, taxes, insurance, maintenance) and renting (rental costs, investment options). Johnson added the current rent-versus-buy debate was on the side of renters due to the reinvestment opportunities: rent the property, take the difference, and reinvest.
A discussion ensued on the importance of having the discipline to save and the role of future relocation plans when considering whether to rent or buy. Owning a home serves as an anchor, which is ideal if you want to stay in an area but problematic if you want to move around. As for the available amenities, Johnson argued that owning them worked better than renting. Owners can apply what Johnson referred to as the kegger premium for amenity maintenance. Steve and Johnson talked about the positive aspects of living in a community with high ownership, such as lower crime, higher educational outcomes, and stable child-rearing environments.
Market Momentum
The conversation then switched to market changes such as momentum that occurs with rising prices and pricing events. A pricing event could happen in three ways: prices could go down; it could take longer to sell your home than expected; a seller could get caught between having purchased a new home before selling the existing home. Johnson stated that the market was currently experiencing a price rise with demand starting to drop off, making it a less-than-ideal time to buy a home.
From a historic perspective, there was still a limited demand following the peak of the housing market when prices became too good to pass up.
Interest Rates As Key Factor
Ken refers to interest rates as the big overhang in the housing industry. The potential for higher rates is a key indicator in the health of the real estate market. If interest rises and the cost of home ownership skyrockets, then renting and reinvesting would certainly be the better financial alternative.
So if you’re weighing the benefits of owning versus renting, as with many conundrums, it all depends.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: We talk a lot about real estate on this program, but we haven’t really gotten or done a deep dive in a long time. And by deep dive, I mean taking a look at housing trends and prices in our local market. So I’ve asked Ken Johnson, real estate economist at FAU, which is Florida Atlantic University, to join me today and to share some of this terrific research. Hey, Ken, welcome to the show.
Ken Johnson: Good morning, glad to be here.
Steve Pomeranz: So you’ve recently written some articles or contributed to some articles where you’ve discussed that real estate prices and demand have reached certain levels. And you basically made a statement here that says, where have all the good deals gone? What are you saying there?
Ken Johnson: Well, when we look at prices in Palm Beach County, we’re definitely above the long-term pricing trend. So at this point in time, all the good deals are gone; we’re above that pricing trend. Many people, however, are still buying because they’re trying to lock in a price before, they fear, it can get too high.
Steve Pomeranz: What is a good deal? I mean, how do you measure a good deal? Versus what? Affordability versus historic trends?
Ken Johnson: Well, so we’re looking at historic pricing trends. So we have about 40 years of data and it’s an HPI, housing price index, so it’s pretty much like the DOW. So you’re looking at percentage changes, and so with the 40-years worth of data, we simply run a linear trend through. We’d run a line through it and say where should you be? You should be on that line.
Steve Pomeranz: Yeah, like a smoothing out line.
Ken Johnson: That is correct. That is correct. And then we look at where should you be, but where are we today and just calculate the percentage difference.
Steve Pomeranz: And to restate it, we’re above that trend.
Ken Johnson: That’s correct.
Steve Pomeranz: To what degree?
Ken Johnson: Just under 20% of Palm Beach County.
Steve Pomeranz: Just about 20%. So is that an egregiously high amount? I mean, I’m thinking back to like 06. And we’re going to touch on 06 a lot, or later rather, or 06, 08, because real estate, obviously, we all have a little bit of post-traumatic stress disorder there, worrying about is the next bubble coming? But what level did it get to back then?
Ken Johnson: So we’re at 20% now. And while that number is a little shocking, if you look back to where we were at the peak of the last bubble, it was 66%.
Steve Pomeranz: Okay, so we’re nowhere near that.
Ken Johnson: We’re nowhere near that.
Steve Pomeranz: All right, now, a homeowner or someone who is looking for domicile has a couple of choices. You don’t have to own, you can rent. And you guys have come up with this index which I find to be terrific and quite fascinating. Taking a look at the difference or comparing the idea of renting versus buying. Take us through how that index works.
Ken Johnson: So in simplest terms, what we try to do is we look at, think of two houses, perfectly identical across the street from one another. One is rented at the market value, the other is sold at the market value. So you look at it in terms of wealth creation. The owner is going to have to assume the cost of ownership, mortgage payment, taxes, insurance, maintenance, etc. On the rental, you have the rental cost. But then you’re taking these sort of rent differentials in terms of what you would put into the house plus the down payment and what you would not be necessarily putting into the property if you were renting. And you invest that difference in a portfolio, stocks, and bonds, and you see which way, on average, produces greater wealth.
Steve Pomeranz: Okay, all right, so that is the question. So I have a gentleman in my office who’s recently married, they’re looking to have some kids in the near future, and they’re looking for a house. And he’s actually frustrated because he’s not finding the kind of house in the price range that he wants. But I don’t know that he’s really considering renting, in a sense, because he says, well, we need another bedroom, and all of this. But today, what is the rent versus buy index telling us?
Ken Johnson: Right now in southeast Florida, this number actually works for the Tri-county area, because we have three counties worth of data that we build the calculus of if you will. So when we look at the number right now, it’s at 0.28. That roughly sits in this three-county area in southeast Florida as about a 15% chance to own and create wealth, as opposed to rent the same property and reinvest in that portfolio of stocks and bonds. So we’re favoring ownership, excuse me, we’re favoring renting right now, instead of ownership. But there’s a lot more that goes into ownership than just an investment.
Steve Pomeranz: But let’s take a look at those numbers because I do agree with you, and I want to get into this aspect of what it really means to own a home. So out of 100 people, 15 will benefit from homeownership? So 85 would be better off renting?
Ken Johnson: Renting and reinvesting.
Steve Pomeranz: Okay [LAUGH] yeah, reinvesting. Yeah, so really, in the real world, I don’t think people are re-investing the difference. I think in the academic world, you’ve got to do something with that money, but I think what we’re saying here basically is that if you’re a disciplined saver and you’re really thinking about creating wealth and your home is part of that equation, for that person, then this metric is very valuable to you. If you can rent, take the difference, reinvest it in a diversified portfolio of stocks and bonds over time, right now, where prices are in the buying market, you’re probably mostly better off renting.
Ken Johnson: I would answer the question three ways. There’s three things that drive should you be renting or owning, that we can find in our research. And one hits on the key point that you’ve been talking about, the discipline to save. Home ownership is, at its basic setting, what it does is it forces issue you to save. So this is a great thing, this is how Americans have been able to take advantage of the leveraged financial investment in which they happen to be living in, for years, and years, and years, and years. But it forces you to save, and so as it works out, it will be better if you are a disciplined saver, for example, on average, to rent and reinvest. On the other end, if you’re not as disciplined of a saver, you would perhaps be better off to own and build equity.
Steve Pomeranz: Yeah.
Ken Johnson: Couple other points, if you tend to be upwardly mobile and you’re thinking about moving, especially from one metro area to the other, renting and reinvesting, I should say, is like a call option. And it’s a lot less expensive too.
Steve Pomeranz: And owning a home is an anchor.
Ken Johnson: That’s correct.
Steve Pomeranz: And it’s not as liquid, it’s expensive to sell.
Ken Johnson: It’s very difficult to sell.
Steve Pomeranz: Very difficult. So if you are upwardly mobile, I think that’s an excellent point. This idea of being able to move when you need to move and not to have the baggage, so to speak, of owning a home.
Ken Johnson: That’s correct.
Steve Pomeranz: That’s really very important.
Ken Johnson: That’s correct.
Steve Pomeranz: With regards to the amenities of renting, you see these ads for these places, and they have these great gyms and tennis courts and all of that, but it’s not quite so simple as that. Tell us about the amenities for renting and the amenities for owning.
Ken Johnson: So when we looked into this, we came up with a shocking conclusion. If you really like amenities, on average, you are better off owning.
Steve Pomeranz: That is shocking because you think of all those people having so much fun in the gym and all that. [LAUGH].
Ken Johnson: Well, but it turns out, think about it this, if you are the owner of property that you are renting and you have a really nice set of amenities, what you tend to do is apply a premium because the tenants in your property will not take, on average, as good a care as owners do in the same property. So you simply apply a renter’s premium.
Steve Pomeranz: I see.
Ken Johnson: Sometimes we refer to that as the kegger premium.
Steve Pomeranz: The kegger premium, okay. I’m sorry, that’s because of keg, you mean like a keg of beer?
Ken Johnson: That’s correct.
Steve Pomeranz: I’m sorry, I’m too old to remember all that well. Okay, the kegger premiums. So even though you don’t actually know it, they’re pricing in their costs-
Ken Johnson: They are.
Steve Pomeranz: Of that appreciation and that extra maintenance in the rental price.
Ken Johnson: All the data shows that.
Steve Pomeranz: Yeah, okay, so if you own your own home, you have your own pool and maybe you have a club membership somewhere, a member of a tennis club or something like that. You’re better off, generally speaking, than renting, in this case.
Ken Johnson: That’s correct.
Steve Pomeranz: Okay, by the way, my guest is Ken Johnson, real estate economist at Florida Atlantic University, and we’re talking about the real estate market, and we’re trying to get down to the numbers here. And, Ken, this is fascinating stuff. I love the way that you guys are measuring demand in the marketplace, and therefore, kind of somewhat a predictor of future prices. If demand is slackening, then future prices may go down. If demand is increasing, the reverse is also true. But it’s also important to remember that a home is not just about investing. It’s about consumption, and there’s other benefits to owning a home. Let’s list some of those real quick.
Ken Johnson: Sure, so it is a consumption. It’s also a necessary good, we all have to have shelter. But it’s consumption in terms of we enjoy it. Other things that come out of homeownership, research shows again and again, you get better societal outcomes in terms of higher voter participation, lower crime, higher educational outcomes. So there’s lots of reasons to own that aren’t necessarily financial in nature.
Steve Pomeranz: I know in my own experience, I notice that, if you’re bringing up children, it’s better to have a more stable community which is represented more by homeownership than it is a rental community, where it’s more transient. Maybe populated by a lot of upwardly mobile people who are [LAUGH] looking to move out. But I think it’s a little bit more difficult perhaps to build strong long-term relationships for your children and their parents.
Ken Johnson: While that’s not our area of research, I couldn’t disagree with that. I would think, anecdotally, that’s exactly what I would expect to happen.
Steve Pomeranz: Okay, I want to get back to this question about rising prices and the fact that the markets are different today that they’ve been in the past, we’re talking about real estate markets here. In the past, real estate used to be kind of consistent, steady increase or slow decline, but that’s changed. Tell us how that’s changed.
Ken Johnson: Absolutely, we’ve seen a change. So we had cycles in the past. Even in our data, we see some cycles, but there was very little movement above or below that long-term smoothing trend. The last two cycles, we’ve had dramatic swings above and below. So that brings in the question of the timing of when you purchase or when you sell.
Steve Pomeranz: Yeah, so let’s talk about that. Now there is a metric that you and your partners have created, which gives us a basis to make that decision. So as prices are rising but demand is starting to decrease, what does that tell a potential buyer?
Ken Johnson: If prices are rising, in real estate, unlike equities, you do tend to get momentum.
Steve Pomeranz: Mm-hm.
Ken Johnson: Okay, so you can get prices that will overshoot the mark in terms of housing prices. So prices are rising and demand is starting to slacken, then you can expect sometimes in the near future to have a pricing event. Now, a pricing event could come in several forms.
So there’s three things that could happen in a pricing event. Prices could go down, properties could extend their marketing times, and/or the likelihood of a transaction during a given marketing effort could precipitously fall. Now, that’s pretty critical to people that have to sell.
Steve Pomeranz: Okay, let me recap that a little bit. So prices could go down.
Ken Johnson: That’s correct.
Steve Pomeranz: Right, or it could take longer to sell your home-
Ken Johnson: That’s correct.
Steve Pomeranz: Which would create pressure for prices to go down, I would think, because people are going to start cutting their prices. And what was the third one?
Ken Johnson: The third one is the likelihood of a transaction during a given market period. In other words, I have to sell. I’ve already bought another home, I’ve lost my job, I’ve transferred to another city.
Steve Pomeranz: Okay, got it, got it. So where are we? So in that term, we are in a rising pricing market today, right?
Ken Johnson: At present, that’s correct.
Steve Pomeranz: But your numbers show that demand is starting to taper off.
Ken Johnson: That is correct.
Steve Pomeranz: Okay, it’s not generally the best time to buy if price is the key.
Ken Johnson: That’s correct.
Steve Pomeranz: Again, there’s all these other reasons to buy a home, but if we’re just taking a look at the numbers, it’s not the ideal time to buy right now.
Ken Johnson: That’s correct.
Steve Pomeranz: Okay, let’s take the reverse. Let’s take post-06, and assuming that you had capital, and you weren’t shut out of the market, you had good credit, you would see prices were falling but demand was rising. Let’s say that would be the perfect setup. I don’t know if that actually happened, you take it.
Ken Johnson: So what happened right after the peak, there was still a limited demand. You saw prices falling, and the demand from homeownership was also falling. But what was happening simultaneously is that prices were getting to be good. And at some point in time, roughly around ‘12, we saw a bottom in almost every market in the US, where we hit our price point to where you could say, people were just saying, that price is too low. That price is too good-
Steve Pomeranz: I’m not selling.
Ken Johnson: Or I’m buying. No, I’m so sorry, the prices were so good by ‘12 and our index score was definitely reflecting an increase in the demand for homeownership and people started buying.
Steve Pomeranz: And that would have been the time to buy. So it’s, in a sense, an investment. All investments really kind of work the same. They have different characteristics.
Ken Johnson: That’s correct.
Steve Pomeranz: They have different levels of liquidity and rates of return and things like that. But it’s still a question of value for your money and the cost of money. And this is another thing I want to close with. A lot of this is driven by interest rates. So when mortgage rates were at 7%, I could only afford a house worth x. If interest rates drop to three and a half percent, theoretically, I could own a house 2x. It’s not exactly, but-
Ken Johnson: It’s on the debt service, yes.
Steve Pomeranz: Yeah, and we see this in corporate America all the time now. Companies are paying huge prices for other companies because their cost of debt is so low. So it’s just kind of the law of gravity; it’s the way money works. To what degree are interest rates? Now, interest rates have come down recently. And I don’t know if it’s necessarily filtered into the mortgage market, but any minute it’s going to. Do you think there’s a possibility for increased demand and we’ll leave it there?
Ken Johnson: Sure, on interest rates, this is really the big overhang that we have. I think, Steve you and I are of an age where we can remember much higher interest rates.
Steve Pomeranz: Much higher.
Ken Johnson: And so this really hangs in the back of our mind. What happens if we do see 7, 8, 9, 10% interest rates again?
Steve Pomeranz: Oh, wow.
Ken Johnson: Quite honestly, it would be a disaster for the housing market.
Steve Pomeranz: Oh yeah, yeah.
Ken Johnson: However-
Steve Pomeranz: What about 5%?
Ken Johnson: Even 5%, relative to where we are right now because all financial experiences are local and recent. We much more remember the near term than the things in the far, distant past. So right now, rising rates is the big threat in the housing market. However, we noticed that the rates went up and then they flattened back out. And if you look at the yield curve, I get so tickled if they’re talking about the yield curves inverting, it’s virtually flat right now between the one and the ten years.
Steve Pomeranz: Yeah, but the point is that your numbers would show demand slackening may be a result of the higher interest rates we were seeing three or four months ago.
Ken Johnson: Well, here’s what would happen in our model because we look at the cost of home ownership and then the reinvestment alternative for the renter.
Steve Pomeranz: Oh, okay.
Ken Johnson: So the cost of home ownership would skyrocket, which would force down the demand, meaning the monthly, the periodic cost would go up. If interest rates went up so much, that pricing, that cost, would be so tremendous that people would actually start to demand less home ownership because they could, on average, outperform renting and reinvesting.
Steve Pomeranz: This is the kind of stuff that we don’t really talk about a lot on this show. I don’t know that a lot of people are talking about the numbers in real estate the way you think about investing in businesses or in the stock market or on the bond market. And I really appreciate you coming in. To hear this, and any interview again. If you have any question about what we’ve just discussed or a comment, visit our website, stevepomeranz.com, to join the conversation. And while you’re, there sign up for our weekly update for upcoming live events and the important topics we’ve covered this week straight into your inbox, that’s stevepomeranz.com. Ken Johnson, real estate economist at Florida Atlantic University, thanks for joining us.
Ken Johnson: Enjoyed it, Steve.
