To buy or not to buy…

That is the question.

That may not be Hamlet’s question, but that is certainly the question looming over potential buyers as they try to decide whether or not to purchase a home right now. I’ve said before that comparable rents is a key indicator of market fundamentals and I still think that holds true today. To truly account for all the pieces of the puzzle, prospective buyers should take all the factors into consideration. That means property taxes, HOA fees, maintenance, insurance, mortgage payments and the whole works.

While that may be the best way to go, it requires multiple calculations and as far as I know, most people don’t bring a laptop with them to open houses. Enter the GRM – gross rent multiplier. It’s a simplified version of the calculations that investors have been using for years. It’s not a precise analysis (as it doesn’t take into account paid utilities, taxes, insurance etc), but it wasn’t meant to be more than just a gut check. Using the GRM would give you a quick overview to determine whether the rental cost will cover the cost of ownership. This is a good tool for investors, but also very useful for potential buyers looking to evaluate RE values.

Overall Annual formula
Market Value/Annual Rental Income = GRM

Monthly formula
Market Value/Monthly Rental Income = GRM

There as been much debate as to what magic number is the “right” GRM. I tend to think there is a GRM range instead of a single value since it’s really just an estimate. Many have used the overall annual GRM of approximate 15 (15 x 12months/yr = 180 monthly GRM) for rent savers and approximately 8 to 10 (9 x 12months/yr = 108 monthly GRM) for cashflow investors.

Let’s apply this quick calculation to some Arcadia properties that are both for sale and for rent.

#1) 900 Victoria Dr. 91007
4bed, 2bath, 2034 sqft in Peacock Village
Rent $2900/month (Craigslist)
Asking Price $880,000 (Redfin)
Annual GRM: 25.3
Monthly GRM: 303.5

#2) 130 W. Longden Ave. 91007
4bed, 4bath, 2913 sqft in central Arcadia
Rent $3900 (Craigslist)
Asking price $1,328,000 (Redfin)
Annual GRM: 28.4
Monthly GRM: 340.5

#3) Similar New Construction Townhomes
3bed, 2.5bath, ~1865 sqft off 2nd St.
Rent $2850 (42 Diamond St. Craigslist)
Asking Price $750,000 (50 Genoa St. #B Redfin)
Annual GRM: 21.9
Monthly GRM: 263.1

These are good examples how the gross rent multiplier can be useful. Although not a precise evaluation, these GRM numbers are so far beyond the traditional, acceptable range of 160-200 that there’s no point in even considering a purchase. Surely one can argue that the GRM is just an arbitrary number, but it only takes a few calculations to show that the ownership carrying costs for these properties are more than double that of the rental cost. It makes absolutely no financial sense to buy these homes at these prices when you can rent them for much, much less.

There’s a long way to go before rent savers and investors jump back into the market to create a bottom. The NAR will probably call the bottom five or six times before the actual bottom even begins to form. Sit back, grab a drink and enjoy the show.

5 thoughts on “To buy or not to buy…”

  1. Good analysis, I live in Arcadia as well and the housing price hasn’t drop like the Inland Empire and the OC.

  2. Housing prices haven’t dropped in the same magnitude as that of the IE, but it has begun to move. Volume always preceeds price in RE decline and LA Times reported that the LA County sales have dropped 50%. The larger price reductions are right around the corner.

    Traditionally, IE housing falls earlier, faster and steeper than say LA or OC because of its location. This is consistent with the previous bubbles as well.

    Welcome to the blog, Avenger. Good to see some local Arcadians on the site ๐Ÿ™‚

  3. I agree with your analysis of the properties with the exception of the assumption of static rents. I think one scenario is for rents to fall as well, which would drive prices even lower. I wish I had a way of putting probabilities to that scenario. Otherwise, I’m glad to see a local blogger focusing on the ridiculousness of the san gabriel valley.

  4. Renter – It’s difficult to comment on the probability of what the market will do. It’s easy to track the local rental market, but it’s also fairly time consuming. You make a good point about falling rents and I won’t be surprised when/if that happens.

    Welcome to the blog ๐Ÿ™‚ Glad to have some SGVers on board.

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