Top Place in the Country to Buy a House is Unthinkable

The Rust Belt may be struggling, but that's exactly why it's high-time to purchase a home or an investment property.
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NEW YORK (MainStreet) — By almost any measure the Rust Belt is doing badly: the population's declining, people are earning less and Detroit became the largest city ever to file for bankruptcy protection.

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But if you're thinking those are good reasons to stay away from real estate in the region, think again. Seven of the ten most undervalued housing markets are located in Michigan, Ohio, Illinois or Indiana, according to MainStreet analysis of 168 metropolises.

"We're seeing ridiculous pessimism" in the rust belt, comparable to the "ridiculous optimism" that drove the nationwide housing bubble before the last recession, said Dean Baker, co-director of the Center for Economic and Policy Research.

That "ridiculous pessimism" causes home prices to fall but doesn't have a similar impact on rents, which measure the real value of living in a city. When cities become less desirable places to live, people won't pay as much for housing, so rents drop; when they become more desirable, people spend more, so rent increases. Home prices should rise and fall too, unless fear of the future or speculative optimism distorts their value.

Nowhere has fear distorted home prices as much as in the Rust Belt. In Detroit, home prices fell 35% between 2001 and 2013, according to Zillow's Home Value Index. Over the same period, rental prices increased 29%, according to the Department of Housing and Urban Development's median three-bedroom dwelling rent estimate. The result was that rental prices rose a whopping 65 percentage points more than home prices over the period, making it the most undervalued market in the country.

The Motor City may be a shadow of its former self, but the rental prices indicate that it's not going to disappear altogether. The auto industry is again profitable and the city benefits from being within spitting distance of the University of Michigan. And that's not reflected in housing prices.

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"When the real estate bubble popped, the pendulum swung way too far," said Drew Sygit, principal at Royal Rose Properties, noting that it's not uncommon to find $40,000 properties on the city's outskirts that rent for $900 a month. "People threw the baby out with the bathwater."

And the baby's been chucked in cities beyond Detroit. Saginaw, Mich. rental prices increased 54 percentage points more than home values between 2001 and 2013. Rockford, Ill. and Grand Rapids, Mich. rentals increased 44 percentage points more, Lansing, Mich. and Dayton, Ohio rentals increased 42 percentage points more and Indianapolis, Ind. rentals increased 41 percentage points more.

Outside of the Rust Belt, Gainesville, Flor., Lakeland, Flor. and Las Vegas rounded out the top-ten undervalued metropolises. The analysis excluded cities, mostly in California, where the increase in rentals over home prices appeared to be correcting for real estate price increases in the late 1990s, before the scope of the study. About half of Gainesville's gap also appeared to be due to a run-up in housing prices in the late 1990s.

Other data also indicate that buying a home in the rust belt is a good move. It takes Detroit homeowners only two years for their home purchase to be a better financial deal than renting, the shortest time of any city, according to Zillow's Breakeven Horizon, which takes into account monthly payments, upfront costs and projected changes in home values. In all seven of the rust belt metro areas identified in MainStreet's analysis, homeowners who stay in their houses for at least 2.7 years will be financially better off than renters, compared with a national average of 3.1 years.

But if you have an eye on a rust belt property, don't take too long to act. Just as the housing bubble popped, undervalued housing markets will correct themselves.

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In Indianapolis, that process is being helped along by hedge funds, which started "heavily" buying blocks of rental properties in the area about six months ago, said Scott Adams of Indianapolis-based property management firm Realty Wealth Advisors.

"It won't last, I always warn investors," said Adams. "Don't get used to this."

--Written by Simone Baribeau