I’m a fan of renting (and today, Ranting). Reading time: 5 minutes
Aren’t you throwing money away paying rent?!
That’s a question I often hear. I rent an apartment in downtown Cleveland and have since 2012. When I share this with friends, family, and colleagues, it’s not unusual for someone to say that they’d love to live in the City, but they would rather own a home than throw away money on rent… Gee, thanks!
Having owned two houses (both as rental properties), I now know many of the large costs of home ownership. These additional costs are overlooked, especially by first-time home buyers. It seems like something is always breaking, needing an upgrade or requiring maintenance.
There are overlooked advantages to renting beyond financial, such as flexibility and convenience, and there are non-financial advantages to owning a home such as pride of ownership and the ability to make it your own through renovations and remodeling.
Renting Vs. Buying
In my experience, homeownership costs at least ~50% more than renting per month. $1,000 in monthly rent does not equal $1,000 in mortgage payments. There is at least an additional ~$500 of maintenance, interest, taxes and insurance for home buying (and that’s before furniture, furnishings, renovations, remodeling, lawnmower or landscaper, and the dog for the backyard).
While it’s likely your rent will increase, your property taxes will almost certainly increase as well, and sometimes significantly more. (I’ve found that by being an excellent tenant and negotiating you can negate some rent increases.)
Speaking of property taxes – it’s worth asking: do you ever really “own” your home since you’ll always have to pay property taxes? If you ever fail to pay your taxes, you could lose your home all the same.
Selling Your Home
Selling a home within 5-10 years of purchasing risks negating any financial gains (i.e., closing costs and realtor fees, approximately 5% of selling price). Also, the national housing market or just your neighborhood market could take a downturn.
Sure, renting your house is an option if you want to move and can’t sell right away (though many homeowner associations prevent renting). But have you ever been a landlord? It’s not fun and can reduce your selling price later. Your tenants won’t take care of your home like you did and rented homes can have an unpleasant stigma to homebuyers.
The biggest issue with owning a home is the complexity of selling it and moving to another. I don’t know about you, but I’d rather do nearly anything than pack up and move. And it’s true that you’re likely to move more often if you rent than buy. But it’s nothing compared to listing, negotiating, and selling your home – all while juggling the timing for your next home purchase.
I’ve moved for reasons including the need for more space, the ability to walk to work, and simply to upgrade. That flexibility can be extremely valuable despite the headache of packing.
If my family grows, moving to a bigger rental unit is a lot easier than remodeling my home or enlisting a real estate agent to sell it.
What if you find an amazing job opportunity in another city, state, country or even just the opposite side of town? Home ownership nationally can actually lead to higher rates of unemployment due to a lack of mobility. 1 This happens because people buy a house in one location and it limits their ability to take a job in another location. It’s not only a detriment to the individual, but to the entire economy.
Investing and Home Ownership
Purchasing a home represents an extremely high concentration of wealth, particularly if you don’t have many other investments. Think about it: Would you ever concentrate such a large portion of your wealth into any other asset? If your home is one of many investments, with true diversification, your risk lowers significantly.
Rent is an expense, but a mortgage is debt.
Lastly, a mortgage drags down your debt-to-income ratio, limiting your opportunities for other investments. Rent is an expense, but a mortgage is debt.
How Your Home Performs as an Investment
There’s simply too much emotion tied to a home to consider it an investment. I distinguish a “home” from general real estate in that a home is your primary residence. Real estate includes rental property, which can be an excellent investment.
Let’s assume you want to buy a $200,000 home and have $40,000 for the 20% down payment (great job saving that down payment!). We’ll also assume that after 30 years the value has increased to $475,000, roughly tracking inflation. 2 Let’s consider how your investment in a home compares to investing that down payment otherwise, using CAGR. Disclaimer: This is for illustrative purposes only, investing of any sort involves risk.
Example 1 – Same home for 30 years, value more than doubles
Let’s see what your return is on the purchase of that home, living in it for 30 years and selling at a large gain. I’ll assume no maintenance costs, although over 30 years you can expect some major repairs such as needing new appliances, basement waterproofing, roof repair/replacement, water heater, etc., but we’ll assume none of those things happen in this first scenario.
A gain of $275,000 is a lot, and depending on laws and your personal situation (again, do you trust that the next 4-8 presidential administrations won’t change the rules?) you might not have to pay any taxes on it. You end up with a 2.93% return before any closing costs, taxes, etc. A smaller rate of return than it seems at first glance, since it takes such a long time. 3
Example 2 – Same Home for 30 years, Value More than Doubles, + maintenance costs
Let’s see how taxes, maintenance and non-deductible mortgage interest of $500/month affect your return (for a total of $180,000 over 30 years, in this example). Your actual expenses could be much higher than this. Again, we assume the value increases from $200,000 purchase price to $475,000 sale price in 30 years.
By assuming a $500/month maintenance, interest and property taxes, the return drops to 0.75%!
You might be thinking, “but property tax and mortgage interest are deductible, you aren’t considering all the savings from that!”
Mortgage interest deduction is a portion of the large amount of interest you’re paying, and with tax law changes in recent years you’re less likely to take advantage of the deduction, or at least not fully. Further, your mortgage is 15-30 years; again, do you trust that the next 4-8 presidential administrations won’t change the tax laws (as happened recently)?
Similarly, property tax is an expense that, while deductible, is money you already spent. You only receive a small portion back, perhaps 35%.
Example 3 – Invest Entire Down Payment in Stock Market
What if instead of using that $40,000 as the down payment on a home, it was invested in the stock market all at once and left alone for 30 years in a low-cost index fund. Assuming that it grows 7% per year over 30 years, you’re left with a gain of $264,490.20 (and no closing costs).
If it’s unclear, this provides a 7% return – WAY more than double the prior two examples!
Example 4 – Difference Invested for 30 years
Let’s say you’re like most of us and don’t have $40,000 to invest right now. Instead, you commit to invest the money saved by renting instead of buying (using our earlier example of renting for $1,000/month instead of spending $1,500/month on a home) into a low-cost index fund.
Now, granted you end up investing more money, but you end up with a MUCH larger amount at the end: $606,438.25 for a gain of $426,438.25. (You also spread the initial $40,000 invested in the other scenarios over nearly six years.)
Throwing BIG Money Away
My point is simply that it is not as cut-and-dry as “you’re throwing your money away renting”. On the contrary, it is closer to a certainty that you’re throwing big money away by NOT renting.
Disclaimer: Buying a home is a major decision and warrants more consideration than just money; emotions like pride of ownership and security play a major role for many of us. My analysis herein is an effort to refute the common belief that renting is throwing money away, particularly in the short-term and early in your career and life.