renting vs. buying

Economic Scene Time to Buy? The Conversion of a Renter By DAVID LEONHARDT Published: May 28, 2008

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I think this article on the buy vs. rent decision is good, but the author ignores a factor in favor of buying -- over the long term, house prices can be expected to rise at the rate of inflation, on average. For a $600K house, a 3% annual gain is $18,000, which cannot be ignored. A related fact is that if the costs of owning a home, including mortgage payments on an amortizing fixed rate mortgage, are currently only slightly higher than renting, it makes sense to buy, because rents can be expected to rise with inflation over time, but the payments on the mortgage would not. Property taxes and home insurance costs probably rise with inflation, though.

I'm not making a short-term forecast of house prices here.

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Reply to
beliavsky
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Since we are down over 14% so far this year, and 8% last year, it is going to take a decade for your 3% to break even, assuming things don't get even worse. If you are buying a house as in investment, you are squandering your money. You can do far more using more conventional investing tools. A house is shelter, and that is an expense. You decide how much expense you want to pay for, then find a living arrangement that works within those guidelines. The fact of the matter is that rent is a great deal right now, and has been for several years. The rent money that you pay on many rentals would not begin to cover the cost of ownership.

-john-

Reply to
John A. Weeks III

wrote

I saw this article this morning, too. It is a worthwhile read. It repeats one of T. Borek's points on the subject, a very good one IMO, concerning the historical ratio of sale prices to comparable housing rental rates.

I respectfully disagree that one should expect as much as 3% a year. I think Robert Shiller is the best source on this subject. His data argues appreciation is less than 1% a year over the long run. See for example

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foresaw and wrote about both the tech bubble and the housing bubble bursting. Guy's a wizard AFAIC. Plus of course those who bought during this last bubble may not be seeing any appreciation on their houses for some time.

Right, and to put it out there, so do the costs of a new roof, furnace, painting the house, etc.

Renting is often a very sound financial decision. One day it will again be fashionable to live within one's means.

Elle, whose childhood home, with many improvements, is now on the market, having appreciated some 5% a year since my parents sold in 1987; whose current home has appreciated some 40% in five years (big knock on wood); who in 2001 sold another home with an appreciation of 50+% after five years; and who still refuses to buy any home with the expectation of doing more than getting the original purchase price (sans inflation) back, due to much reading about historical home prices and bursting bubbles. One's home is no way no how an ATM. The only returns one should expect are a safe and comfortable place to live.

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Reply to
Elle

I can't resist asking the following question: How do the landlords make money? Is any landlord that bought property during the boom years bound for bankruptcy?

Anoop

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Reply to
anoop

I don't know... I live in central Florida (on the west coast) and using the formula from the article I'm running a rent ratio of over 21 (using just/market value, 25 if I use comparable sales value.) According to the article "a rent ratio above 20 means that the monthly costs of ownership well exceed the cost of renting."

I also happen to know that a full 41% of my rent money goes directly into paying the taxes on the home, and I expect that another 40% or so goes to paying the home-owner's and flood insurance (The Gulf of Mexico is in our back yard.)

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Reply to
Daniel T.

That is a factor in favor of *borrowing*, not buying. If investing at a fixed rate in times of inflation is bad, then borrowing at a fixed rate in times of inflation must be good. Pay back with cheaper dollars.

If they bought at the *beginning* of the bubble, which where I live was mid-2003, they are doing OK. Not as great as if they had sold two years later at the top of the bubble, however.

Thank you. It's frustrating when discussions on this topic (the subject of the thread) omit these key points.

Not to be nosy, but since you brought it up: are you saying you bought your parents home twenty-some years ago? That is an interesting financial planning technique...of course, the $250/$500K Section 121 home sale tax exclusion was not in place that long ago. I have a friend who also bought his parents home some fifteen years ago, when he was still married, although I have a vague notion it involved some tax benefits to the parents via installment sale.

-Mark Bole

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Reply to
Mark Bole

Not only that, but also rents themselves rise along with inflation as the years go by. Owning your own home gives freedom from worry that your landlord will decide to jack up the rent next year and maybe more the year after that. And that can be very disturbing in old age when your pension check may stay about the same year after year.

These comparisons of renting vs owning rarely take into consideration all the many factors involved. The calculations often look good on paper. But that money you think you are going to save by renting can easily slip away.

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Reply to
Don

example

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His 1% number is for annual *real* (after inflation) appreciation, and I was thinking of this when I estimated a long-term 3% annual gain, assuming 2% inflation.

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Reply to
beliavsky

Landlords are able to depreciate property as well as deduct interest from income.

Successful landlords don't buy properties that they can't rent for a profit.

-- Ron

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Reply to
Ron Peterson

"Mark Bole" wrote Elle

That's true. Though I want to be clear that IMO factoids like this may recklessly be used an argument for speculating into bubbles. It's perfectly reasonable if a family needs a home or someone just wants the comforts of a house and puts down 20% etc. on a conventional mortgage (or carefully examined for affordability ARM) and then buys during a bubble.

What's interesting is that I believe Shiller and other sources provide evidence the bubble started in the late

1990s. Anecdotally, I sure saw this in my neighborhood when I bought my first home in 1996. Talk about luck. OTOH, no doubt evidence exists to show the bubble really took off when interest rates declined and banks got so "clever" (read: Fire the whole board of Washington Mutual).

Oh no; the asking price is way out of my league. Plus it's way too big. My father just happened to write me today that "the old house" was on the market, and I could see photos of it and its improvements at xyz realtor's web site. At the same time, we discussed the economics of its appreciation.

Somewhat related: Fixer-uppers where the buyer does his/her own repairs and lives in the house are one area of real estate investing where I think everyone I know comes out ahead. Like you suggest, I suspect the tax break is a large part of the decision to go into this "business." (Again, speaking only anecdotally and admittedly without any sophistication on real estate development.)

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Reply to
Elle

wrote

You are right. My mistake.

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Reply to
Elle

Many landlords are losing money. Many bought into the idea that you have to own real estate, and real estate always goes up. The idea is to get in, make up for the cash flow shortage each month, the property goes way up in value in a short period of time, then sell for a huge profit. The problem now is that properties have dropped 14% this year and 8% last year, so many landlords are stuck with cash-flow negative properties that they cannot sell, and they are going down with the ship.

-john-

Reply to
John A. Weeks III

IMHO, not retirement-wise, when having a roof paid off is a wiser situation than being at the mercy of landlords, maintenance and property taxes included.

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Reply to
Augustine

We are? Real estate is so regional that it's hard to discuss it in general. Many areas of the country never really had a bubble. So while prices are somewhat down or stable, we aren't seeing the kind of drops that you're describing.

As far as rent vs. buy, in a brief, non-rigorous, purely anecdotal check, I couldn't find any similar houses (3bed, 2bath, 1750sf) in my area that rent for what I pay in mortage/tax/ins/upkeep. And that's with having a 15-year mortage. Had I selected another 30-year when I refinanced in 2001, my totals would probably be $150 month less or so.

However, that was a small sample, those that have advertised in the local paper recently. There weren't many comparable properties to look at. An agency would probably have a better selection and a fuller picture.

Brian

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Reply to
Default User

Agreed about the local aspect. Zillow.com, which seems pretty accurate for my area, shows my house down 12% off the peak which occurred around mid-2005. For what it's worth, we are down 4% YTD. My retirement plan is to assume we will stay in this house. If we downsize, maintenance goes down, and a bit of cash comes out, but I never planned the house to add to my net worth. Fresh data sometimes lags, but I'll maintain that right through 2005, there was no real bubble. The huge bubble was in the late

70's through early 80's. I charted this and provided supporting data sources at
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Reply to
joetaxpayer

In the area where I live, this buy-vs-rent issue comes up a lot in financial columns in the newspapers, in lectures and seminars put on by advisors of various types, and elsewhere. If you know a little about the person giving the advice, it is usually easy to predict which position they will advocate. Most who strongly urge "buy" are real estate professionals and a few fee-only financial planners. Those who urge "rent" are almost always stock brokers or commissioned mutual fund sales people. Big surprise! Nothing like a little unbiased financial advice for the education of consumers.

Here is where it gets ugly: Back during the tech boom when stocks were all the rage, some financial advisors were recommending to seniors who owned their homes free and clear to take out home equity loans and put the money into mutual funds. The calculations on paper were convincing. In the long run stocks have always increased in value. So why let all that money sit in a house untouched. Real estate is a thing of the past! Look at what stocks have been doing in just the last few years! Besides, interest rates on bank loans are low. You can make money with a cheap bank loan and stocks that are sure to go up!

A lot of seniors took the bait, and a few lost their homes and unwillingly became renters. Personally I have never heard of a single person who actually profited from this strategy. After the tech stock bubble burst arount 2000, you didn't see much of this kind of advice any more and many of these former "advisors" were nowhere to be found.

My guess is that almost all successful financial planners with good reputations who have been in business a long time own their own homes, and that almost all successfull and affluent real estate brokers have quite a bit of money in stocks.

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Reply to
Don

Thirded! My neighborhood (three phase subdivision) is only 20% occupied. Our phase is the oldest and only 50% sold. My wife and I have noticed that prices haven't reduced at all. Rather, houses are sitting on the market about twice as long and new construction has slowed (but not stopped). Nothing solid, just our everyday observations.

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Reply to
kastnna
[...]

You are confusing cash flow with income/expense. Isn't part of your mortgage payment going to principal? That's not an expense. Don't you have equity tied up in your house? That's opportunity cost. Don't forgot those extra transaction costs every time you took out a loan, what if that money had been invested instead? And then there's that 6% or more hit you'll take when you do eventually sell.

Your estimate of upkeep is probably low. It's pretty much a given that after twenty years, even with replacing a few water heaters, kitchen appliances, HVAC, and a new roof, parts of your house will still be seriously out of date compared to the market. I'm talking cabinets, flooring, countertops, fireplaces, windows, landscaping -- the big ticket items.

No one is at the mercy of a landlord. It's much easier to leave a bad rental situation without excess cost than a bad homeowner situation.

I've been a homeowner for nearly 25 years, also a landlord and renter on several occasions over the years. But I have no illusions as to the true economic costs of home ownership.

-Mark Bole

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Reply to
Mark Bole

Do you mean 6% or more in agent fees? Isn't that just a form of business overhead, that gets passed onto the end customer (I.e. the buyer of the house)?

Huh? "HVAC"? Oh, you must be in one of those countries with central heating and cooling. My heating is a portable plug-in unit, and my cooling is an open window. Could be why I get so grumpy whenever it gets below ten degrees Celcius.

However, if you STAY in the house, then it doesn't matter how fashionable your kitchen countertops are. If you are buying a house for stable shelter that you own, then it doesn't matter so much what somebody else thinks of the doors on your cupboards, or the style of the bathtub, etc, etc.

While leaving a rental is easier, there are plenty of people renting in markets with low vacancy rates and high payments. I have read that, in New York, people resort to paying brokers a percentage fee (e.g. one month's rent equivalent or more) just to find a room in a shared apartment. Plus first/last/deposit. Which really does put many people in a vulnerable situation.

Well, if I owned my own place, without any imminent plans to sell, then I could let some things go pretty far. Carpet, paint, etc looking bad. Kitchen countertop isn't fashionable. I wouldn't prioritise that sort of thing, as long as the electricity and plumbing worked, and the roof didn't leak. The time to really care, would be when approaching a sale, and then the fix-up costs are overhead. Or if the place is offered for rental, and the fix-up costs would result in a better quality and higher-paying tenant.

Reply to
Coffee's For Closers

Coffee's For Closers wrote: [...]

Typically the 6% real estate agent commission is paid by the seller. Although, local market conditions, high-end prices, increasing use of the Internet, and sales by owner are all helping to erode the traditional monopoly on listings that have enabled real estate agents to charge this fixed price.

That's just the problem -- no one can stay in the same house forever. Even the supposedly smart retiree who has the mortgage paid off and doesn't keep up the building is just deferring expenses that someone, someday, will have to pay for (or equivalently, offer a sales discount for).

As long as there are folks trying to claim that home ownership is somehow cheaper than renting, there will be a need to inject some basic economics into the situation. Like the post I replied to, often the confusion is as simple as not understanding the difference between cash flow and cost.

The cost of shelter is going to be the same no matter what. There is really no difference between a landlord and a homeowner, except for their relationship to the tenant. An owner-occupied property is simply a bundle of shelter plus undiversified real estate investment, a rental is unbundled shelter only. In the article which started this whole thread, the differences observed in the "rent ratio" were strictly due to the real estate investment portion of the equation, not the shelter.

The decision can and should be based on non-economic factors only. The downside is that all too often, emotional attachment to a specific house results in someone paying for shelter that has become over time way beyond what they really need or can afford.

-Mark Bole

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Reply to
Mark Bole

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