07 May 2007

Jumping into the fray: Renting vs. Buying a Home

This has been a hot topic around the blogosphere lately. The most recent entry I read is from Consumerism Commentary: Renting Makes You Richer. He quotes the argument from an MSN article throughout, so these are not necessarily his feelings. The problem with so many of these articles is that the assumption (or argument) is often made that there is a right way to do things. With the housing market there is most definitely not one answer. It is very dependent on local conditions.

For example, where I live, homes are generally cheap and there is not much difference between a mortgage payment and a rent payment on the same property (in fact, the rent payment is usually more). It's also a market that has not declined at all because it never really got overpriced-- $100/sq ft is about average here now, and it only fluctuates a little from area to area. My house has in fact appreciated considerably since I moved in 2 years ago . . . almost 18 percent, using a conservative estimate of the current value.

So, what do things look like if you live in a market like mine? First of all, rent payments save you virtually nothing and often cost you more per month than owning (including taxes and insurance). For my house I think I can state with confidence that rent would be more than my mortgage and escrow payments. But let's assume it's equal. Then renting saves you no money over buying, so there are no additional monies to invest. The only savings from renting would come in maintenance costs. For my house, that has mainly been yardwork and improvements we've made inside and out. I estimate that among painting, mowing, and landscaping, we've probably spent $2,000 in two years. I can't think of any other significant maintenance costs that I wouldn't have if I were to rent. So there's your monetary difference: $2000 over 2 years.

What do I get for that $2k? About $6k in equity from mortgage payments and more than $20k in appreciation, for a net of $24k. If you can find me another investment that would have earned me 1100% in 2 years, I will jump on it. I know what you're thinking-- 18% appreciation in two years is not ordinary. And I agree. So assume that it tracked inflation instead, appreciating 6.1% in those two years. Then my appreciation is only $8k instead of $20k, and my total return is only $12k instead of $24k. So we're talking a mere 500% return on my $2k. Yawn.

That's ignoring the tax benefits of owning the home, which most people get. To be fair, it's also ignoring my down payment. The argument still works, since I could have put down much less than I did without incurring considerable fees (no PMI at my credit union). Suppose I include the down payment in my house investment "costs." Then my extra expense is $15k instead of $2k. But you have to add that $13k to my equity as well-- so my return is $37k. That's a return of 150%. And again, even if you suppose this happened in an average real estate market returning only inflation-- 6.1% over 2 years-- I've spent $15k to earn $25k. That's a return of 67%. It would have taken some really good stock picking to get that in 2 years, and we all know the risks involved in stock picking.

Alright, alright, what's the bottom line? The bottom line is that in my market, renting would have been inferior to owning even with average appreciation. With actual appreciation my returns have been tremendous, and could not have been matched by renting and investing. Not even close. In a market where rent was much lower than a mortgage payment (as in Flexo's example), I can easily see the argument for renting. But it ain't so here.

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