Homeowner vs. Renter: Why Should You Ever Buy a House (at all)?

http://patrick.net/housing/contrib/servitude.html

by vlad • 18 years ago

33 61 18 years ago

Of course, at this time the housing bubble is still deflating, so this kind of calculation heavily favors renters in many areas.

The guy at Shadenfreude Central, a.k.a. www.irvinehousingblog.com, recommends computing the ratio of a house's sale price to the monthly rent for an equivalent house. The charts on this page:

http://www.irvinehousingblog.com/blog/comments/wot-3-22-2008...

assert that the national historic norm for this number is about 180: i.e. a house that rents for $3k should cost about $3k x 180 = $540k. As a rule of thumb, if the sales price is significantly more than this calculation would suggest, it's a good time to rent instead of buying.

Having said all that: The reason to buy a house was well articulated by Christopher Alexander in A Pattern Language (which, as all pattern-wielding Java programmers should know by now, is a classic):

Pattern 79. YOUR OWN HOME

People cannot be genuinely comfortable and healthy in a house which is not theirs. All forms of rental - whether from private landlords or public housing agencies - work against the natural processes which allow people to form stable, self-healing communities...

This pattern is not intended as an argument in favor of "private property," or the process of buying and selling land. Indeed, it is very clear that all those processes which encourage speculation in land, for the sake of profit, are unhealthy and destructive, because they invite people to treat houses as commodities, to build things for "resale," and not in such a way as to fit their own needs.

And just as speculation and the profit motive make it impossible for people to adapt their houses to their own needs, so tenancy, rental, and landlords do the same. Rental areas are always the first to turn to slums. The mechanism is clear and well known. See, for example, George Sternlieb, The Tenement Landlord(Rutgers University Press, 1966). The landlord tries to keep his maintenance and repair costs as low as possible; the residents have no incentive to maintain and repair the homes - in fact, the opposite - since improvements add to the wealth of the landlord, and even justify higher rent. And so the typical piece of rental property degenerates over the years. Then landlords try to build new rental properties which are immune to neglect - gardens are replaced with concrete, carpets are replaced with lineoleum, and wooden surfaces by formica: it is an attempt to make the new units maintenance-free, and to stop the slums by force; but they turn out cold and sterile and again turn into slums, because nobody loves them.

People will only be able to feel comfortable in their houses, if they can change their houses to suit themselves, add on whatever they need, rearrange the garden as they like it; and, of course, they can only do this in circumstances where they are the legal owners of the house and land; and if, in high density multi-story housing, each apartment, like a house, has a welldefined volume, in which the owner can make changes as he likes.

keating3• 18 years ago

Some items the article is glossing over:

First, the rental value doesn't take into account inflation. House payments are fixed, which means it gets effectively cheaper every year. Meanwhile, rents keep increasing. This means that while you can catch a house at the bottom of a bubble and lock in the price, if you rent in that same area, you'll find rents going way up when the housing bubble rises again.

Next, an 800 sq. ft. apartment isn't equivalent to a 1000 sq. ft. house with a yard. If you really want to cheap out on a house, get a mobile home -- though of course that doesn't include land, which is often leased.

Further, in this example, it assumes you have the difference between the two prices free and clear to invest -- you'll certainly need to make sure your investments do well, because at the end of 30 years, you aren't going to be a homeowner, and will still need a place to live.

Not to mention, pets are typically a problem; you're at the mercy of your landlord; the rent can be increased at any time; you have to deal with shared walls with neighbors; and your 6% return is not going to seem very exciting in 5 years when housing picks up again and that $400k house is worth $800k. It WILL pick up -- the country isn't becoming LESS crowded.

Your monthly investment amount will decrease every year as your rent gets increased, meaning your return is not going to be as good as depicted, especially if wages stagnate (as they effectively have in many sectors for the last 8 years). At 5% rent increase per year, you'll eventually be paying around $4000 for that same apartment in 30 years. Around year 20 the apartment costs more per month than the house. (This is a great area, remember, so the demand will be high. In some areas the rent can jump by 20% in a year instead of 5%.) This would mean you'd do significantly worse than if you bought the house.

The basic premise of this article is really "what if you live cheaply and invest your money vs. what if you spend all your money on housing and your house appreciates more slowly than an index fund".

Step 1. Live in your parents' basement for 30 (more) years.

Step 2. Invest the WHOLE $2400 per month on an index fund.

Step 3. Profit!

As you can see, the article ignores things about having your own house that are nice -- like a stable place for people to visit since you don't move every few years to cheaper places; not being at the mercy of parents or landlords; having a yard; not having to obey "quiet hours", and so forth.

hugh2• 18 years ago

You made pretty much the same points that I was about to.

However, since I live in the Sacramento area I will add that his numbers seem way off. $400K doesn't get you a 1000 sqft two-bedroomer nowadays, it gets you quite a nice three or four bedroomer (say, http://sacramento.craigslist.org/rfs/672061645.html)... or a huge six-bedroomer if you want to live in a new suburb (http://sacramento.craigslist.org/rfs/676328067.html)

The $950 a month for a one-bedroom apartment is about right.

mattmaroon2• 18 years ago

Ok, that makes much more sense. As I said in my earlier comment, his ratio seemed really far off.

Sacramento must have been hit pretty hard eh? I looked there 2 years ago and seem to remember prices being considerably higher. I was looking at a new 2 br attached for about $350k in East Sac.

daniel-cussen• 18 years ago

I agree, the article ignores many positive aspects of homeownership. However, some of the points you make are poorly founded. For instance, there's no guarantee a 400k house in Sacramento will be worth 800k in five years, solely because US is becoming more crowded. It's a bold claim. Also, the idea of being at the mercy of your landlords is weird. In markets with a lot of excess inventory, some landlords can't find tenants. This puts them at the tenant's mercy. Second, if you own a house, you can be at the mercy of the bank, or the local home owner's association, or some such.

Some points are good, though; if one takes out a fixed-rate mortgage, payments are fixed and will become less painful as inflation makes them smaller in absolute terms.

keating3• 18 years ago

> For instance, there's no guarantee a 400k house in Sacramento will be worth 800k in five years

Sure, but based on historical events with housing in "great" areas, this can and does happen. If you buy right before a bubble, it can even happen sooner -- in a couple years. A 6% fund is not going to even have the chance to do that.

> In markets with a lot of excess inventory, some landlords can't find tenants.

A given, per the article, is a "great" area. Great areas are always in demand. I have not yet lived in an area that lacked for tenants.

pchristensen4• 18 years ago

"It WILL pick up -- the country isn't becoming LESS crowded."

That's less important than the fact that the country is getting richer (despite wage stagnation). Poorer people can lower their expectations for safety, space, etc, but the richer you get, the more you want. I moved from 800sf in an old high rise to 1000sf in a suburban apartment complex to an 1800sf house within 2 years as I got out of school and my income increased. I could save 60% if I had stayed in my apartment, but I'd rather pay extra.

mattmaroon2• 18 years ago

$400k for a 2 br place is expensive by national standards, which would make Sacramento a high-priced real estate market (not hard to believe, most of California is).

He claims $949 a month is much higher than median for a 1 br. That does not seem to fit with what I've seen in high priced real estate markets. By comparison, in Ohio, a brand spanking new two bedroom detached condo (nobody builds 2 br homes in most parts of the country, so you couldn't find a newish one) in a great area would cost maybe $150-175k. But rent on a good one BR apartment is still $750/mo.

I've looked at places in a lot of markets (midwest, Vegas, Bay Area among them) over the last 5 years and if what he says is true, it makes me think the rents in Sacramento are depressed for some unusual reason, and the ratio of mortgage to rent is atypical, and therefore not permanent.

My off the cuff guess as to why would be the terrible real estate market there. It's so hard to sell a house right now for more than you owe the bank on it that a lot of people have taken to renting them out instead, creating an unusually high number of rentals. It's a lot easier to rent a place out at a few hundred bucks below mortgage and pay the difference out of pocket than it is to sell it and pay the bank the 50k you'd owe them after. If you're doing well enough to afford two mortgages, you can pick another house up at a good price, move there, and rent the old. That's exactly how we got our place in Campbell, and what a lot of the places we looked at in the bay area were doing as well.

So maybe he shouldn't buy a home in Sacramento, at least right now. There are lots of times in various markets where this happens and it's financially beneficial to rent until the ratio swings the other way.

timr5• 18 years ago

By comparison, in Ohio, a brand spanking new two bedroom detached condo (nobody builds 2 br homes in most parts of the country, so you couldn't find a newish one) in a great area would cost maybe $150-175k. But rent on a good one BR apartment is still $750/mo.

Where are you getting your numbers? I grew up in Columbus; most of my friends and family still live there. The cost of a condo there is anywhere from 30-50% more than what you cite, and the rent for a 1BR apartment is 20-30% less.

chris• 18 years ago

This may hold true, in certain areas, if you keep the same house for 30 years. I read somewhere that the average American home changes ownership every 11.9 years.

I did a quick calculation on the percentage ROI after 1 year of owning a $300K house.

home cost: $300,000

10% down payment: $30,000

30/yr mortgage @ 6%: $1,618.79

tax at 1.25%: $312.50

maintenance/misc: $200.00

actual mortgage payment: $2,131.29

investment after 1 year (($2,131.29 * 12) + $30,000) = $55,575.48

appreciation after 1 year at 4%/yr: $12,000

percentage ROI: ($12,000/$55,575.48) = 21%

what index fund are you going to see a 21% return on investment from? did I make a horrible mistake?

menloparkbum• 18 years ago

vanguard emerging market stock index fund was doing that well for a while...

dmv• 18 years ago

Three obvious ROI friction factors you missed:

1. Closing costs.

The mortgage is not a free transaction, for the buyer. There are a lot of services (inspection, title insurance) and misc charges. That's a couple thousand dollars. I don't know what the rule of thumb is; I know that it ended up being about $11k for a mortgage less than $300k, and that's without points or any other mortgage instrument issues.

2. Equity.

Almost all of your payments in year 1 go to interest with 10% as the downpayment, you'd probably owe about $266.7k -- play with an amortization calculator. If you sold the house for $312k, the difference would be about $45k. That's $45k back for your $55k... except

3. Selling fees.

The seller in a transaction is typically responsible for paying the real estate agent fees for some combination of seller and buyer. That's 3% each (if you both used something like redfin.com, it would still be 4% total). That's up to 6% of the $312k -- $18.7k.

So, with #1 you increase your investment requirements (call it $10k, so $65k for the year). With #2 you decrease your net ($45 on the $65k). With #3 you decrease your net even more ($26 on the $65k). On the plus side, you typically only make 11 payments in the first year, so you're only out $37k instead of $39k!

Summary:

Real Estate transactions are not efficient, low-friction or highly liquid investments. Duh. This has a positive and negative aspect - you have the potential for outsized appreciation because of the illiquidity, and because transaction costs keep the potential market (somewhat) more constrained. But you also have greater penalties on shorter ownership cycles.

Conclusion:

One year is an awful timespan for a house purchase unless you're completely confident in an extreme appreciation or you are investing additional sums or sweat equity which may guarantee the extreme appreciation (ie, a flip). It has to be extreme.

ssharp2• 18 years ago

You need 20% down to avoid PMI, don't you? PMI is mortgage insurance if you don't have enough equity in your house. I'd guess that could run an extra 2-3 hundred per month.

You're also missing homeowners insurance which would probably end up being close to $200/month for a 300k house.

You ROI doesn't really make sense to me.

You're paying a little over $1340 / month in interest, $200 for homeowners insurance, $312 in tax, and $200 for PMI. That's $2052 / month in housing costs where none of that money goes towards principle. Now depending on how you're doing your taxes, most of that is tax deductible, so lets say that's going to save you about 20% of that - $19,700 is the cost of your housing per year ($1,641 / month).

Furthermore, 4% growth isn't guaranteed - especially with the current housing slump. The growth in housing experienced from the late 90's - early 2007 will likely not happen again anytime soon. I thought traditional growth was more like 2-3%. Plus, appreciation has to be considered in the long term. You need to pay capital gains if you sell the house within 2 years and any sunk costs on the house sitting vacant or realtor fees will lower your actual returns on the sale.

So if the house is worth spending $1,641 / month vs. what you could rent for $1,641 OR you plan on living in that house for a significant period of time where the fixed cost of ownership becomes valuable, then buy. If not, renting is still the better option.

For young people who aren't stable and might be moving around, I just don't see the benefit of home ownership, especially in today's uncertain housing market. Once you're ready to settle down, home ownership is a better idea.

vaksel2• 18 years ago

I think having the ability to have a home equity line is reason enough to buy. That's 100-200 thousand dollars credit you have at your disposal for a rainy day. And unlike credit cards its not at 30% apr.

ssharp2• 18 years ago

If you have decent credit, you can generally get credit cards at, near, or even below a HELOC rate. I have two credit cards that I don't use (well I put 1 fixed payment on each every month to keep my credit score up) with limits at $30k on each. With the money access checks they give me with promo rates, I could easily sit on 30k each year, just bouncing the balance back and forth anywhere between 0 and 2.99%.

vaksel2• 18 years ago

yes thats an option but those credit cards last like 6 months before you need to bounce them. And you need to qualify for the credit. With equity line you qualify once at your best at then you can still get access to it if you no longer work/have bad credit etc.

timcederman• 18 years ago

http://www.burbed.com/ makes me glad I am a renter.

TheWama• 18 years ago

Investment return rate, rent/buy cost ratio, inflation and home appreciation (or depreciation) rates all matter. It's a lot to consider.

Luckily, the NYTimes put out a great calculator for just this:

http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAP...

fharper1961• 18 years ago

One thing nobody seems to mention is that the owner has to pay for the maintenance of the home, while the renter doesn't. Over a 30 year period there will be quite a lot to do.

brfox2• 18 years ago

I LIKE home maintenace.

raganwald• 18 years ago

Landlords factor that in to the rent. Here in Ontario, we have rent control legislation, so rents do not move with the market. However, the landlord is permitted to raise the rents when the cost of maintenance rises.

If you don't want the hassle of actually dealing with maintenance, you can purchase something like a condominium, where a management firm handles the maintenance and you write a cheque each month.

So... I'm suggesting the maintenance issue is orthogonal to the ownership issue.

rsheridan63• 18 years ago

True, but landlords usually either do their own maintenance or know who's good and cheap. The average person might tend to get ripped off by incompetent or unscrupulous repairmen.

axod4• 18 years ago

Not this old chestnut again :/ Buy a house. Now. In a stable or up and coming area. Do it. I know things.

axod4• 18 years ago

Surely arguing that renting is cheaper than owning implies that landlords make a loss - which I'm sure is very rare.

brent• 18 years ago

Isn't it funny how this is never mentioned in these articles. I'm both a homeowner and making a profit on my renters :-). Keep renting guys!!

Tichy2• 18 years ago

What makes you think it is rare? Genuine interest, I have no knowledge about it. I know cases were renters pay less than the monthly rates paying of the credit for buying the house.

Wouldn't it be kind of zero-sum? Either you live in the house yourself, than the calculations apply, or you live somewhere else, but then (simplified) your rent equals the rent your renters pay, so it cancels out and the calculations would still be correct.

axod4• 18 years ago

Of course. I'm sure it's common in some parts that landlords make a loss in month to month terms, but then once the mortgage is paid off they own it and sell it, and it's gone up massively in price. Maybe that's their big pay day.

I'm sure other landlords make a very good profit month to month also. But if landlords were making a loss in real terms over years, they would probably stop doing it.

protothomas• 18 years ago

I know that in the UK at least a lot of landlords get 'buy to let' mortgages, where you only pay off the interest on the loan, which obviously makes the payments (and rent) cheaper than a normal mortgage. This does though rely on the house price remaining the same as when you bought in order to pay the full mortgage off at some point.

Fuca• 18 years ago

Renters definitely lost over a short period of time the secret is they do it for the long run, now the article kind of makes logic for your first house.

timr5• 18 years ago

It's not that rare in Seattle -- a renter here is paying something like 30-50% less per month than an owner of an equivalent space.

This is one of the principal arguments that the local housing market is overinflated. You can't take out a mortgage to pay rent, so it tends to be better reflect economic fundamentals.

pchristensen4• 18 years ago

But that only applies to landlords buying new properties now. A landlord who bought their property 5 or 10 years ago has VERY different cost structure than someone who bought last year. They can offer rents lower than a landlord with a new mortgage.

Don't assume everyone has a new mortgage at full market prices!

mhartl2• 18 years ago

It doesn't imply that. Owners and renters have different risk profiles (or ought to). In financial terms, most new homeowners are *highly leveragedC in real estate. Unless you are a skilled speculator, this probably represents more risk than you intended. Landlords absorb this risk, and are compensated for it.

mhartl2• 18 years ago

That was supposed to be highly leveraged. Not sure where that 'C' came from.

brfox2• 18 years ago

It is rather ridiculous that this author would not include the simple fact that rents nearly always go up... especially over 30 years.

Tichy2• 18 years ago

That doesn't seem to be true. Doesn't "irrational exuberance" talk about that? Something can be the case for 20 years, but then change.

hugh2• 18 years ago

Sure, but the point is that "constant rent for 30 years" is a pretty lousy assumption.

rsheridan63• 18 years ago

I expect rents to go up considerably, given that people are avoiding buying houses, population is increasing (expected to be 500M by mid-century), and inflation is high (I don't see any way out of the US government's debt mess other than inflation to reduce its real value).

So in 10, 20, 30 years a renter will be paying considerably more while a buyer will be paying a rate locked in long ago.

Imagine the relative pittance you'd be paying now on a loan locked at 1988 housing prices - and that's after 2 decades of inflation rates that were lower than those of the next 2 decades will probably be.

icey• 18 years ago

I bought my house in 2001, and for me to rent an equivalently sized house now is already $600 to $1000 more expensive per month than my mortgage. It was a bit worse a couple of years ago, but still; people who forget about rent increases are in for a big surprise if they could have gotten a house for a reasonable price.

vlad• 18 years ago

A good benefit of renting is that you could travel anywhere you want to for months or years, especially if you're in a startup in the digital space that focuses on making money every month instead of raising Venture Capital. You could travel across the country or internationally. You could do this frequently, and live in places that are cheaper per month than your mortgage or rent--which is going to be especially true for almost every other country if you live in an expensive city already, but still true if your current rent is $1,000. One might not want to buy a house unless they plan on living in it for at least a few years (there are web site calculators that compute how long you have to live in a house to make it worth it, factoring local rent, buying and selling costs, and the small interest you would earn on the difference between the rent and mortgage price.)

tesla• 18 years ago

What the author seems to miss is that if you rent for 30 years, you still have to buy or rent a home for year 31. Whereas, if you own your home for 30 years, in year 31 your housing payment is $0 + maintenance, which I'll guarantee is less than the rent the author would be paying.

johnrob• 18 years ago

Yes, but the renter's balance is higher than the future value of the owner's house (which the renter could then buy in cash and still have money left over).

One thing that was ignored is the increase in rent over time. By year 30, the monthly rent will probably be higher than the mortgage payment (in the calculation, we assumed fixed rent over 30 years).

aggieben• 18 years ago

I think the main consideration when talking about renting or buying is the time involved. In Texas, I've found that if you're going to live somewhere for at least 2 years (or so, depending on the market), and you set out to find a particular standard of housing (i.e., fix the square footage, etc), it's cheaper to buy. Under three years, unless you find a good deal, it's probably cheaper to rent.

Retric2• 18 years ago

The real advantage to renting is it reduces the cost to move. Try running the numbers assuming you move every 3 to 7 years costing you 4% of the value of your home and see how the numbers look.

nradov• 18 years ago

Of course the answer is always "it depends". If you want to run the numbers, here is an excellent Excel spreadsheet that will analyze the rent vs. buy decision for your personal circumstances. http://randolfe.typepad.com/randolfe/2006/04/bubblizer_a_req...

petercooper• 18 years ago

This article is wrong. Admittedly, some problems occur due to its US-focus. In the UK, for example, residents pay property taxes, not just owners, so you pay the same property tax whether you own or rent the property, removing that advantage of renting.

The figures for the mortgage versus renting are bogus in any case. The writer has not compared like to like. An apartment with people walking around above you is not the same as a HOUSE. It is therefore no wonder the rent is 2.5 times cheaper than the mortgage.. it's on a property that's subjectively at least 2.5 times worse. Like for like, the mortgage on a similar apartment would be a lot less than $2500 a month.

Given increasing population, rents and property prices are unlikely to rise at just 0.4% above inflation over the next 30 years. While the mortgage payment can only go up based on interest rates (and it's not /that/ hard to lock into a fixed rate right now..), the rent will go up in absolute terms. Assuming a 3% rise after inflation, the unlucky renter will be paying $2303 per month at year 30, and very little will have been put into savings for the last 10 years. Worse, they won't have an asset - the homeowner will.

Buying a property with a mortgage gives you incredible leverage you'd struggle to obtain with other investments. The bank won't loan you $400,000 to invest in stock, but you can invest in a property this way.

Given that rising rents will cause the renter to barely be saving anything by year 20, that the renter will have no property and a less than exciting savings account come year 31, and that the renter has had to put up with all sorts of restrictions that come with rental properties (no modifications, often no pets, no guarantee you can stay there), I think the homeowner is a lot more wise if they plan on staying put for at least a few years.

Renting is a nightmare even if it proves to be cheaper in the /short-term/. If you're an automaton that doesn't mind uprooting whenever your landlords say so, perhaps it'll work for you. But for those of us with kids, pets and geographical attachments, owning a home gives us both an asset we're invested in using the bank's money for leverage, and a permanent base that only severe economic conditions can take away from us.

alps• 18 years ago

Try explaining this "logic" to a family with a newborn when the landlord decides to kick them out! Owning a home is security. Also, as noted by tesla, at year 31 you no longer have a house payment. I hope the people who advocate renting for life like paying rent after they are retired!

aardvarkious• 18 years ago

If you want to play with numbers, the New York Times has an excellent tool:

http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAP...

It allows you to play with multiple variables and then tells you how many years you need to own a home for in order for it to become profitable.

nazgulnarsil2• 18 years ago

1. pay downpayment 2. let other people rent from you, pay mortgage with that rent 3. profit.

the downpayment you made gets paid back into the equity on the house within the first couple of years. everything after that is FREE EQUITY.

nazgulnarsil2• 18 years ago

also: I blame this partly on the attitudes of today's generation. they can't seem to distinguish between owning and borrowing.

Is music DRM preventing people from making good financial decisions in other aspects of life?

geebee• 18 years ago

The economist and the financial times started recommending renting a few years ago - and they acknowledge that this was a remarkable turn of events.

That said, I think that deliberately renting is a short term play - one that paid off for folks who stayed out starting 2004 or so. These people will probably be in a stronger position to jump in later (though it's incredibly hard to know exactly when... and I suspect this bust will go on for a long, long time).

That said, when I was looking for apartments in SF a few years ago, I met people over the age of 50 who were losing their rent controlled apartments. They were truly shocked at the prices, and were angry about it. Of course, I'd never actually come out and say this, but I thought it: "you've been in SF for 25 years, was there really never a good time to buy?"

Maybe not. I grew up in SF, and over the course of my life, housing has gone from quite expensive ( early 70s) to very expensive (late 80s) to brutally expensive (early 00s). I actually think that a lot of people just never quite managed to get a toehold, and I feel bad for them.

Personally, I'm making payments on an expensive 1200sqft house with a little yard in an unfashionable corner of the city. It may well be worth less than I paid for it, but I locked in a 30 year fixed loan, and I'm not struggling to pay the morgage (though it is a big chunk of my pay).

When I bought, I actually would have predicted a downturn as well. But I don't really act on those beliefs - any more than I get into and out of equities based on where I see the stock market going. My best guess is that housing has a lot further down to go (something I believed as early as 2002 or so) - but my guess is no better or worse than what any other astute reader of the business section could come up with. But I'm a lot more confident in my belief that when I'm 55, I'll be glad that I own my hous and that I'm not worrying about whether I'll lose my rent controlled apartment.

I still think that starting early, investing in stocks and owning your own house, is by far the winning long term strategy.

altano• 18 years ago

It's harder to rent a nice place than it is to buy one. In general, landlords don't take care of rental units as well as they would their own house, and the same goes for the tenants. Of course, we're just talking percentages, but in the end it makes it much harder to rent a nice place.

Homeowner vs. Renter: Why Should You Ever Buy a House (at all)?

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