Wednesday, July 18, 2007

Why Owning is Almost Always Better Than Renting

This excellent article does a good job of explaining why owning your own home is almost always better in the long term than renting.

It comes down to one thing: inflation. Mortgages can't adjust for inflation, while renting can. Thus while the renter faces steadily increasing rents, the owner eventually will be paying a fraction of the original real value of the mortgage. The owner starts by paying more, but eventually pays far less.

This effect takes place even without factoring in appreciation, but if you do factor in a moderate appreciation, the effect is much more pronounced. While your house's value goes up 4% a year (even though your mortgage does not), the renter's rent goes up 3%.

Combining that with the leverage of only having to own a portion of the total equity in the house and you have a near unbeatable victory for owning versus renting. If you plan on living in a place for 5 years or more, you should strongly consider owning,


second class citizen said...

But if you're poor and can't buy a home, you get to work (perhaps two jobs) so that your landlord doesn't have to, and you pay for the landlord's retirement even though you won't be able to retire.

Ir's like redistribution of income, only in the upward direction.

Alex said...

I am not a landlord at all, so I don't know. I know I could never rent out my home in any kind of way that would cover the mortgage (at least not now)

Lazy Man and Money said...

It looks a little bit like the buy vs. rent argument that I've seen in the past. There's got to be a price where it's no longer worth it to buy even if you account for inflation. For instance homes in my area (Silicon Valley) cost about $850K to buy, but you can rent them for as little as $2000 a month. There's a wide discrepancy there. For exaggeration sake, let's say that it becomes $1000/mo. to rent and 1.25M to buy. How long is it then before inflation makes it better to outlay the cost for a home. I'd like to see some calculations on this.

Alex said...

Well the article does some calculations, but I'll do some based on my situation.

I found a comparable house to the one I live in for $2000 a month, I pay a total of $2624 a month for my first mortgage + condo fees. Assuming rents would go up at around 3% a year, by my calculations a renter would be paying more than me in 10 years.

However of the $2624 a month, $324 goes to principal (equity), so it would take 5 years for my aggregate interest, condo, and taxes to be less than what a renter pays.

During that 5 years, if my house (worth $420K) appreciated at a rate of 3% a year (keeping pace with inflation), my equity (the 20% down payment) would have increased by 79% (inflation adjusted 68%)in 5 years just from the appreciated value.

Alex said...

Also, the $24000 I pay in interest and property taxes probably saves me an additional $4521 in taxes ($24000- standard deduction of $10300=$13700 X maginal tax rate of 33%= $4521). Thus I am paying $23079 per year in interest, property taxes, and condo fees for my house versus a renter who is paying $24000.

Anonymous said...

Inflation is very important but I don't think it tells most of the story. Other relevant factors include:

1. The opportunity cost of your down payment. (If you're making Buffett-esque returns of 22% compounded, buying is virtually NEVER the right option)

2. Marginal propensity to save: How much of the income that would be spent on mortgage payments is going into higher yielding investments? How much is going in WSOP entrance fees? I tend to think this is the biggest reason why although theoretically renting is superior to buying, buying is actually superior to renting. People's categorization of possible consumption is tied to their bank account, not their long term lofty goals. Factor in the secondary psychological effects of disparate courses of action.

3. Measuring price appreciation: Figuring out the probable inflation increase in the value of the home is largely predicated upon what starting and ending dates one uses to determine the measuring time period. We're coming off a housing boom, mortgage rates are at historical lows, unemployment is near historical lows. Let's not figure this is "normal". 4% price appreciation is on the very high end for average home price increases historically. NYC leads the nation (major cities) over the last 25 years in average price increase and its only 7.2%. (though this 4% increase is more probable, historically speaking, in DC or NV then MO)

4. Liquidity

5. Transaction costs: Very high for real estate. If you're going to move every 24 months this factor alone should be dispositive.

Anonymous said...

I'll add one more. Rent control. In California pre-1979 buildings cannot increase at more than 60% of inflation. So inflation is relatively irrelevant. Not to mention that in some cities, like SF, as mentioned above, a 5-6,000 monthly payment (what our house would cost) compares nothing to the 3,000 monthly that we're paying in rent. Furthermore, in California Prop. 13 makes it so that the owners of the building are paying a fraction of the property tax. In San Francisco, if we bought this property, it would cost $1500 monthly in property tax alone, but our landlords are paying less than $200.

honeymoney said...

Owning is always better than just renting. There is no boubt. It is yours and you can do whatever you want. You can always sell your property at higher price than you bought it.