Rent vs. Own

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YLG_IHB

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<p>I've never really believed the usual rent vs. own arguments. Those favoring owning always point to the tax break (which is much smaller than they let on) or the "Pride of Ownership"/"American dream" arguments that pull away from the financial platform. Renters just point to the monthly expense - i.e. rent while it is cheaper on a monthly basis.</p>

<p>But there is something missing to both arguments. Let's say I can afford the same house for the same monthly cost, either renting or owning - for example $2,500 per month rent, or mortgage + tax. With current inflated prices, that means a substantial down payment is needed. Assuming I can afford the down payment, I think owning will be cheaper as long as:</p>

<p>1. The mortgage is maximum 15 years, ideally 10 years.</p>

<p>2. I have plenty of working years after the mortgage is paid off.</p>

<p>The same holds true for higher "buying" monthly costs, as long as it still meets the budget. This also assumes:</p>

<p>1. I take no risk at all, such as investing that hefty down-payment in volatile stocks (rather choosing safe 5% CDs). Of course, buying a house before the bottom has inherent risk - If I need to sell in a hurry, I will lose money (I discount this risk for now).</p>

<p>2. Housing stays relatively flat from now until my retirement in 30 years. This may actually be a reasonable prediction, since 30-40% declines are fairly assured over the next several years, with inflation picking it up again after that.</p>

<p>3. Rents stay relatively flat for the same time. Tough to say... but with all the overbuilding, it may just happen that way.</p>

<p>I base my comparison purely on maximum amount of money accumulated until retirement. Buying a house with a short term mortgage, and saving the rent/interest for the next 15 years works out much better than renting until retirement (even compounding the down payment). Of course this is purely speculative right now, since the large drops are yet to happen (I predict 2008 and 2009 for the major drops). It would be stupid to buy now, but it may not make sense to wait for an absolute bottom either. It needs to be calculated out each way for the right decision. </p>
 
When we get closer to the bottom, people will recognize there is a premium to rental. Renting provides freedom of choice and freedom of movement. There are no unexpected bills as a renter. When homeowners have been trapped in their depreciating homes by a bloated mortgage long enough, these freedoms of renting will be appreciated as something they want and cannot have. This is one of the psychological reasons markets overshoot to the downside.
 
"and saving the rent/interest for the next 15 years works out much better than renting until retirement (even compounding the down payment). "





What are your calculations for this? The big down payment will grow much faster over 30 years if you put into the stock/bond markets. If you are investing the money over 30 years it makes little sense to put it into something with a low yield like a CD, historically even an index fund will get you an average 8-9% over 30 years. Assuming, you can contribute to a Roth you could slowly move the down payment into it so you can save on taxes.





Assuming historic averages in the markets, I believe its pretty easy to show that you'd be best off if you wait until rent <= mortgage (with at most 20% downpayment) + tax + insurance + maintenance/upgrades and investing any additional cash in tax sheltered/managed investments (After you consider the tax deduction on your mortgage the spread between what you pay and what you can earn can be as high as 4%).



 
the way I look at that (as a homeowner), if you rent for 10 years, your rent money are gone forever. You'll never get them back. If you own for 10 years, at least you have a chance to hit another bubble and get some of that money back. And let's exclude extreme examples of subprimers and so on. Most people took reasonable mortgages and are paying them off on schedule. People who bought until 2003 have enough equity cushion to go on...

many on this forum are waiting for 2009-2010 to buy. Why? Maybe because you expect the market to eventually go up after we hit the bottom?
 
what kind of affordability problem? I have this problem too, b/c I can't afford a 1 mil house (or even 600K), so what? I bought a 380K condo instead, hoping to bulid up some equity and move onto a SFR in a nice neighborhood one day. After reading this forum for a while I can't help but feel like I'm some kind of a criminal b/c I actually own and don't rent :))
 
<i>"many on this forum are waiting for 2009-2010 to buy. Why?"</i><p>

In my case, probably 2012. Because why in the world would I pay $1,000,000 for something when I can buy it in a few years for half the price?<p>

<i>"if you rent for 10 years, your rent money are gone forever"</i><p>

And what do you think interest is? The simplest and best way to clear up this rent money gone forever fallacy is to understand cost of funds. If you can make $50,000 on $1,000,000 per year on a cd, ( 5%), then it "costs" you $50,000 annualy to own a $1,000,000 home if the home does not appreciate or depreciate. You are financially in the same situation as someone who makes $50,000 per year on their $1,000,000 and spends it on rent.<p>

If real estate is depreciating at a rate of 5% annually, then the first year the owner is down $50,000 in recognized, not realized loss, and every year the owner loses more and more, whereas the renter is still breakeven with his original $1,000,000 intact.<p>

To understand this, you need to stop, "the way I look at that (as a homeowner)", and start looking at the situations as a dispassionate observer. You have to pay to live somewhere, whether that payment is principal and <b>interest</b>, or that payment is cost of funds.<p>

And in addition to the above scenario, when re prices get out of whack, one can rent the same property for less than the cost of funds on that same property. In other words, one can rent the $1,000,000 home for $3500 per month or $42,000 anually, thus saving $8,000 per year. And that is before recognizing depreciation and including maintenence, etc.<p>

There are times when it is financially better to rent and times when it is financially better to own residential real estate. No asset class is always profitable, including real estate. And just about any asset class is profitable in the "long run", not just real estate, if you data pick what time frame you desire. Stock brokers say that stocks are always profitable in the long run and realtors will say that real estate is always profitable in the long run. And most of the so called long run profit in any asset class is actually just price inflation. When adjusted for price inflation, the difference in asset classes becomes negligible.<p>

And lastly, there is no tax advantage to paying interest over rent. The tax deduction is discounted into the price of the property.<p>
 
What I don't get is buying a condo that is just like an apartment (people living above you or below you). I'm a homeowner, and like that I have control over my house, and space between me and my neighbors. But in a glorified apartment, I'd have no real pride of ownership, and would hate the fact that one rude neighbor could turn my cosy home into a nightmare. I'd pay a premium to rent vs own in a case like that. No sense in tying yourself into owning an apartment/condo.



The only advantage to owning that sort of property is the possibility of appreciation. But that isn't gonna happen any time soon in SoCal, and even then, you have to factor in what alternative investments would have returned. Were those sorts of condos commonly bought before the bubble, or were they just built to be rental apartments back in the 80s-90s?



Blackacre-seeker.

The money you spend on interest and property tax is gone forever too. If one is a prudent renter, one will be investing the difference in their rent and the cost of owning. So if one is a prudent renter, they will have something to show for their investing over those 10 years.
 
"what kind of affordability problem? I have this problem too, b/c I can't afford a 1 mil house (or even 600K), so what? I bought a 380K condo instead, hoping to bulid up some equity and move onto a SFR in a nice neighborhood one day."





Naive. Clueless. Hoping rather than thinking. More power to ya, buddy.





Sometimes I think we are just shouting into the wind.
 
"what kind of affordability problem?"



blackacre-seeker,

Nobody hates you for owning. That's the thing, most of us would like to own a SFR in a nice neighborhood one day just like you. We just disagree about the best way to get to that point.

If prices are poised to fall significantly over the next few years, owning a depreciating $380K condo actually hurts our progress towards that goal rather than helping it.
 
<p>Don't feel bad. I'm just pushing my money into cd's now. I managed to get then into 6ish %... Unfortuantely I have to keep them there for a few years. By the end of 2010, the cd's should be earning me at least a decent mortgage. But until then, I will not be putting money into a depreciating asset. </p>

<p>Unfortunately in the next year or so i'm going to be going negtative on the money spent into a depreciating asset vs THROWING money away into a rent. But i'm willing to go into a 10-20k hole than a 50-75k hole. So hopefully it will work out. Take it easy and don't work too hard.</p>

<p>good luck</p>

<p>-bix</p>
 
"And what do you think interest is? The simplest and best way to clear up this rent money gone forever fallacy is to understand cost of funds. If you can make $50,000 on $1,000,000 per year on a cd, ( 5%), then it "costs" you $50,000 annualy to own a $1,000,000 home if the home does not appreciate or depreciate. You are financially in the same situation as someone who makes $50,000 per year on their $1,000,000 and spends it on rent."

That is a pretty interesting analysis. The assumption is that the renter invests the money and then pays the rent with the interest. That is cool. You might as well buy a house and pay your mortgage with your interest income too.

What if you are just a regular renter who pays rent out of otherwise available funds (like salary)? Same analysis applies: if you spent 20K a year on rent, that money is gone, b/c you could have invested that money and earned interest at 5% rate, but you didn't. When we talk about depreciation, we talk about a figure on paper. The house is the same whether it appreciates or depreciates. The only time it is relevant when you want to sell it. Besides, you forget about intangible values of ownership (like paint it and upgrade it the way you like without asking anybody's permission (of course, exterior is another thing with HOA's CC&Rs and city ordinances).



"The money you spend on interest and property tax is gone forever too." Good point, that is true. But that part of the payment that goes to principal is not gone. Yeah, shout "depreciation!" I was also making payments on top of my monthly payment (that go directly to principal), so after 4 years, I owe 280K. Would it depreciate to less than that? I doubt it.



And living in a "glorified apartments" makes no sense to me. I have 2 common walls, no one above or below (townhome)...
 
backacre-seeker


I think you are making the assumption that the condor won't depreciate to less than 280K. At this point, no one knows if that will or will not happen. Tokyo real estate lost something like 70 to 80% of its peak value after the big bubble. The way things are going in this country, the Big R is pretty much certain for next year. Of course, one could say that Nikkie lost a huge percentage as well, and at least you can live in your house.


One more thing, HOA usually covers some aspect of the interior as well, you may want to check the HOA documents before starting your home improvement project
 
<p>Everybody's right, in some sense.</p>

<p>I think that the catch is PRUDENT renter. The vast majority of people will simply spend the difference on crap. I know I would. Of course, right now is a horrible time to buy. But you might need to if you have 8 kids and a 2 bedroom place (assuming you could find anybody to rent to you with all those kids.)</p>

<p>So I will hang on to my fully paid-for depreciating asset, and hope that in 10 years it will be up to what it was in 05.</p>

<p>Awgee--was that you over on Calculated Risk saying bad things about lawyers?</p>
 
ll - It was supposed to be funny. I hope you did not take me seriously. Someone did though.<p>

<i>"You might as well buy a house and pay your mortgage with your interest income too."</i><p>

bkas - Read again what I wrote. They are not equal. You can not buy the same house that you can rent with the same money right now. <b>RENTING IS CHEAPER THAN BUYING RIGHT NOW. WAY CHEAPER!</b> And later, owning will be cheaper. It is timing. Not the asset. And not renting vs. buying. It is timing. It is timing. It is timing.
 
<p>Nah, I took is as it was meant. But I admit, that Robyn is a drag.</p>

<p>Wait, wait, maybe she will sue me for defamation!! </p>

<p>Actually, if you read all of my posts, you might be able to figure out who I was..</p>

<p>But it was a great conversation.</p>

<p>Calculated Risk is such a big blog, that you can't possibly keep up with all the comments, unless that is all you do.</p>
 
<em>I bought a 380K condo instead, hoping to bulid up some equity and move onto a SFR in a nice neighborhood one day. After reading this forum for a while I can't help but feel like I'm some kind of a criminal b/c I actually own and don't rent :))





</em>Blah, you shouldn't feel like a criminal. There are other owners here, including myself. The thing is, I have come to the cold hard reality, that I may be upside down in inflation adjusted terms, and I bought in 2002. It sucks, but there is a strong possibility that it will come true. I really do not think I will be equity positive in real terms, until maybe 2012 at best. It may sound pessimistic, but I like to think of it as thinking as a realist. It took ten years for the last peak to return back to the same in real terms. This bubble was much worse than the last one. Even if we do not have the job losses, we haven't had job growth during this one. Without job growth, and still not making up for the tech losses of 2002, it is going to be a while before we can really recover in an economically healthy way.


<em>


Besides, you forget about intangible values of ownership, like paint it and upgrade it the way you like without asking anyone's permission.





</em>True, that is an intangible value, but that value cost <em>you</em> money. The costs to maintain a home or condo are probably the most overlooked cost, when determining your monthly outlay. Granted, I have an older home, and my costs would be higher than a condo. But, paint, carpet, plumbing, etc. are expenses that cost money, but really add little if any benefit/equity for an owner, and a landlord would normally take care of them. A buyer doesn't care if you think the living room is painted with the perfect shade of blue, or that you have granite, or the carpet is berber, or you hardwood floors, or lots of fruit trees. Maybe, when people bought a home just to buy a home would care, but now it only matters if that is what a buyer actually wants, and buyers are in short supply, and will be for a long while.





Do not get me wrong, I have no regrets for buying when I did, but I am not going to fool myself that I have equity coming to me regardless of appreciation, or what I pay to upgrade/fix my home.
 
<p>Graphix - what do you mean you might be upside down in inflation adjusted terms? If there is inflation, your house is locked into a low price but your income will only go up. Basically, the payment will look smaller and smaller. </p>

<p>I always thought the best use of a house is a hedge against inflation so I am confused by what you are saying... </p>
 
<p>IrvineRenter, there is a premium to renting in terms of personal freedom. I agree. There is also a premium to owning, in terms of putting down roots, making good friends with neighbors and planting a long term garden. Also true, and it is an infinite argument which is better, because it is a matter of personal preference. I am trying to steer away from intangibles.</p>

<p>I'm trying to look at the argument in terms of one outcome - how to accummulate the maximum amount of money before retirement, at the least possible risk. I feel that a short term mortgage is the ultimate solution, but each case needs to be calculated independently.</p>

<p>Take a $600K house, that rents for $2,500. With 20% down, renting is cheaper on a monthly basis. The mortgage + tax = $3,400 for 30 years at 6% and 1% property tax (easy numbers for simplicity). This is a kind of nowhere argument, because I can't afford the $3,400 anyway. The argument then becomes do I buy a cheaper 1 BR condo instead, which also changes the flavor of the argument (why wouldn't I rent the same 1 BD condo if that is good enough?)</p>

<p>So what I'm saying is that if I theoretically have enough down payment to keep rent and own the same monthly cost, the owning works out better long term. I put down $300K and amortize the other 300K over 15 years, also at 6%. Monthly payment is around $2,600 with property tax and income tax savings figured in (this is rough since tax savings gets less and less as interest payments fall, I don't have my calculators handy at home right now).</p>

<p>Now I take the 30 years until retirement. If I rent the entire time, I will spend $900K on rent in that time. I will invest my $300K at a safe 5% and earn $1.3 million over the 30 years. So I walk away with $400K at retirement.</p>

<p>If I buy over 15 years, I will spend $150K in interest payments for 15 years, and $180K in taxes over 30 years. But for 15 years after the house is paid for, I will save $2,000 per month - which compounds to $536K. So I walk away with a 600K house (assuming no increase) + $536K - $150K - 180K = $806K.... a lot better than renting.</p>

<p>These calcs are rough... please check if so inclined.</p>

<p>Again, I'm pretending there is no increase in the house value, but that normally is 3% per year. Over 30 years, you could normally expect a pretty large increase - but with a pending drop of god knows how much, it's difficult to factor in. I would guess a 30% drop over the next 2 years, followed by smaller drops and then flat for perhaps 10 years. Buying now is defintely not the optimum. Also, to repeat - buying does have an inherent risk factor. If I buy in 2 years and the market remains slow, I might lose money if I need to sell immediately. This is a fairly small risk for most people.</p>

<p> </p>

<p> </p>
 
<p>YLG and Blackacre,</p>

<p>The problem with this market is the down payment. An "average" house in Irvine costs about $650K. That means you need a reasonable down payment of $130K (20 percent) to get a good rate and not get hit by a PMI/second loan. </p>

<p>Now there is a few ways to get that type of money:</p>

<p>1) Family. Now if you have rich parents or relatives, more power to you. But more and more "baby-boomers" are forced to save for their own retirement and have less to spare for their kids.</p>

<p>2) Savings: Assuming an "average" house hold income of $130K, for a family to save $130K would take about 6-10 years!!!! And that is assuming a savings rate of 10-15 percent. Most Americans save no money at all.</p>

<p>3) Buying a "smaller" place and obtaining equity. This is the prime way in which people were able to buy houses in the last 5 years. A family would buy a place in victorville for $100K ($10K down), sell it to a subprime borrower or flipper for $300K, take the equity and buy a place in the OC for $650 with the new found equity. Classic pyramid scheme since the victorville house is worth no more that $120K . With the bubble bursting and house values falling, that source of income has completely dried up. Instead of obtaining more money for their next house, many people are now upside down and may have already lost the down payment that they put down in the first place. </p>

<p>On top of that, many young people are debt-ridden these days. For example, I am a responsible person who has never been late on a CC payment but have about $130K in student loans. That means, I have to make a monthly payment of $1000 for the next 20 years to satisfy that debt. Go look at the tuition for colleges and grad schools these days. . . unbelieveable. On top of that, a college grad cannot get a decent jobs these days .. . you have to go to grad. school. </p>

<p>BTW: It took me a semester in law school to realize what the heck "blackacre" was. There is of course whiteacre :-)</p>

<p> </p>
 
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