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The Law of Rents

In a previous post titled Hardwork, Intelligence and Profits I spoke about being a homeowner during the rapid decrease of home values in 2008.

When the market was near it’s top I reasoned that the best reason to sell was the “Law of Rents”. I created this Law, so allow me to explain.  The Law of Rents states that there can only be a delta of ~15% between mortgage payments and rents in any area (ignoring downpayments).  Any imbalance will result in shifting rental/housing markets to readjust.

At the market top a mortgage on a 2bdrm/2bath townhouse in my neighborhood with a $30k downpayment would have conservatively been ~$2700 at a selling price of ~$480k. The same townhouse could be rented for ~$1900.

No matter what expected appreciation or tax benefits are taken into consideration, it’s impossible to justify paying $2700/month (plus $30k down) for a home that you could rent for $1900.

Given the Law of Rents, the expected point of equalization for the home previously valued at $480k is ~$310k. $310k is the fair market selling price, the price at which rents and homeownership intersect.

Looking at the local market today, I expect a further decline of 15% from our current home value levels given that the comparables for the same unit mentioned above is currently $360k.

If you think the decline in home values is over, I would argue that the Law of Rents disagrees.


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