Want to get your hands on a crystal ball to predict the future of housing prices in your area?  It may be more within reach than you think.

In recent reports, Deutsche Bank has used the time-tested relationship between rents and housing prices to gauge the future of housing prices. Rent comparison has long been hailed as a fundamental factor in setting the value of real estate. When it is cheaper (or of comparable cost) to purchase a home rather than to rent, a purchase of real estate will make sense for a buyer.

Conversely, when it is much more expensive to own a home than it is to rent, it makes less sense to purchase a home. Any great volume of sales which occurs during such a period, as in the past decade, indicates a possible bubble. Consider, for example, Deutsche Bank’s report of Americans paying about 13% more to own a home in 1999 than to rent comparable shelter. Compare that number with Americans paying 66% more to own than to rent during the great Millennium Boom of the 2000s which brought about the ensuing Great Recession.

Rents, then, can be used as a baseline from which to judge the movement of the market. Deutsche Bank reports that rents are still falling in much of the nation, signaling a forecast of housing prices to drop by approximately 5% across the nation. In California’s Inland Empire, one of the regions hardest hit by the Great Recession, Deutsche Bank reported the cost of ownership is 10% less than rents in the market.

first tuesday take: No one factor, such as the ratio of rent-to-ownership costs, encapsulates  the real estate market’s future, but the trend in rents is certainly a more solid start than the irrational buyer’s frenzy that gripped the market during the Millennium Boom.

For prospective California homeowners and the brokers who represent them, this news should be cautiously considered. As with all real estate, rents and prices vary from region to region and brokers and agents need to determine what a house for sale would rent for and set the ratio of rent-to-ownership cost for that property. Then the question should be asked, “Would an occupant be economically better off renting or owning this property?”

Additionally, the current real estate market is manipulated by lender and government interference to avoid the declarations of insolvency by financial institutions holding toxic mortgages, resulting in the presently unnatural dearth of inventory being available for sale – whether real estate owned (REO) property by foreclosure or negative equity homes by lender short sale discount.

Thus, California rents may indicate that the market is in recovery, but do not yet reflect the reality of a stable market due to the inventory of ever lower prices which in turn require rents to be dragged down to compete.  At the moment, we still are in a vicious cycle which has yet to turn into the recovery’s virtuous cycle of rising sales volume and stable inflation-adjusted home prices.

Prudent brokers and agents are  well-advised to keep track of rents of homes in their sales market to determine the reasonableness of a listing  price, while keeping in mind that California’s real estate market has a couple of years of foreclosures and short sales to go to be fully stable.

For more information on using rents to set property prices, see November 2008 first tuesday article, Market Volatility Factor 5:  Rents. For more information on the fundamental factors which influence California housing prices, see the November 2008 first tuesday Article, The Economic Restructuring of Real Estate.

Re: “Where’s housing headed? Follow rents from CNNMoney.com