This is a post that I originally wrote for the highly-recommended personal finance blog Get Rich Slowly. As such, the style of writing is more geared toward the audience of that site. However, I felt that the post would be of interest to the readers here as well, so I am re-posting it in its entirety. It was posted at Get Rich Slowly on July 16th, where it rapidly became one of the “Most Discussed” and “Most Rated” posts. It was subsequently bookmarked by over 350 people at del.icio.us, featured on Consumerist, and posted to Digg. If you’re a Digg user, I encourage you to “Digg it,” so maybe it can finally make it to the front page there, and get a little more attention. Enough shameless self-promotion—on to the post!
Introduction
“If you rent, you’re throwing away your money.”
“Owning your own home is a forced savings plan.”
“Home ownership is an excellent path to build wealth.”
You’ve probably heard statements like these plenty of times. On television, radio, the internet, and in casual conversation. Such sentiments are common in any discussion that involves home-buying and personal finances. It’s common knowledge that buying a home is a better financial move than renting. After all, you’re building equity instead of throwing away your money, right? Well, maybe not quite… Rather than assuming the “common knowledge” on this subject is accurate, let’s take a look for ourselves at some of the financial differences between renting and home-buying.
A Real-World Example
For the purpose of comparing renting to owning in this post, I’ll be using real-world data gathered from my area (NE of Seattle). Although most first-time buyers tend to move from renting an apartment to buying a larger, stand-alone house, as much as I can I will compare apples to apples.
For rent, I located a 3-bed, 2.5-bath, 1,840 sqft house with an attached 2-car garage, on 0.2 acres. Monthly price: $1,495.
For purchase I found a 3-bed, 2.5-bath, 1,850 sqft house with an attached 2-car garage, on 0.22 acres. Price: $424,950.
The two homes are located within two miles of each other in similar neighborhoods, and neither is located on a busy road. We’ll assume that our hypothetical homebuyer is a married couple with $85,000 in the bank to make a 20% down payment. To calculate mortgage payments we will use a recent 30-year fixed interest rate of 6.25%.
Let’s look at how the monthly costs break down (approximately) for our hypothetical potential first-time homebuyer:
Renting Buying Rent/Mortgage: $1,495 $2,093 Insurance: $20 $163 Property Tax: - $407 Tax Savings*: - ($327) Maintenance: - $354 Total: $1,515 $2,690 *: (less standard deduction)
Right off the bat, you see that simply trading straight across from renting to owning results in a 78% more expensive monthly bill. That’s not exactly chump change. With even a slight upgrade from renting to buying (which most first-time buyers are prone to do), you can easily see how the total monthly costs would be more than double.
“If you rent, you’re throwing away your money.”
Common knowledge says that despite today’s large premium, buying a home is a “good investment” anyway. Hey, at least you’re not “throwing away” your money, right? True, the renter in our scenario spends $1,515 every month that they will never see again. I wouldn’t exactly say it has been “thrown away” any more than money spent on any other good or service is “thrown away,” but granted, there is zero financial return on that money.
However, when you take a look at the breakdown of the homebuyer’s monthly expenses, a large amount is money that will never return, either. Insurance, property tax (less tax savings), and maintenance, add up to $517 every month that is being “thrown away.” Even worse is the amount spent on mortgage interest. Consider how much of a mortgage payment is applied toward loan interest throughout the life of a 30-year fixed loan:
Years % toward interest 0-5 ~80% 6-10 ~70% 11-15 ~60% 16-20 ~50% 21-25 ~35% 26-30 ~10%
In the first five years, approximately 80% of the mortgage payment goes toward interest. That’s an additional $1,674, for a total of $2,191 being “thrown away” every single month by the homebuyer for the first five years. Ouch! In fact, not until the homebuyer has been paying down the mortgage for over 20 years will the amount they are “throwing away” be less than the renter.
“Owning your own home is a forced savings plan.”
As you can see above, if home buying is like a savings plan, it’s probably the worst savings plan on Earth. Would you voluntarily sign up for a savings plan where well over half of the money you deposit in the first 20 years simply vanishes, and from which you can only withdraw money by relocating and paying a 6-9% fee (not on the amount you have “saved” mind you, but on the total sale price of the home)? Of course not. That doesn’t sound anything like a savings plan.
If our potential homebuyer has that $85,000 saved up for a down payment and deposits it along with just half of the monthly savings over buying ($578 per month) into an account at 8% interest, the balance will be nearly $300,000 in just 10 years. That’s a liquid investment, that can be used for whatever you want, no relocation required. Buying a home is not a savings plan. Actually saving money every month is a savings plan.
“Home ownership is an excellent path to build wealth.”
If your goal is to build wealth, you will be much better off investing your money in the stock market than buying a home. While both stocks and housing are cyclical markets, long-term historic trends show that housing appreciates at a rate barely above inflation, while stocks tend to return an inflation-adjusted 7-10%. In our hypothetical scenario, a renter who invested in the stock market with the $85,000 down payment plus the monthly difference between the $1,515 rent and the $2,690 home-buying costs would be over $500,000 better off after 30 years than the homebuyer, assuming 4% average appreciation.
An important thing to consider is that home prices in the United States are just now beginning to correct from an enormous unprecedented run-up in recent years. Despite what those in the business of selling real estate may insist, the correction in housing is still in the early stages. Four percent is most likely overly optimistic for most areas in the next 5-10 years. The only thing we know for sure is that double-digit gains are gone and won’t be coming back any time soon.
Also keep in mind—I mentioned it above but it bears repeating—in order to cash in on any “wealth” you build through your home you will need to sell that home and move. No, “extracting equity” does not count, since that simply results in a larger debt. Debt != Wealth.
Conclusion
For most people buying a home will result in their largest monthly bill (by far), and because they believe that it will bring them wealth or that they are “throwing away their money” if they rent, they often take on a much larger home debt than a prudent budget would allow. It is a real shame when people are driven to get into the housing market because of misplaced notions of imagined financial benefits. Of course, everyone’s circumstances are different, and for some (particularly those that live away from the coasts) the numbers may actually work out in favor of buying.
Don’t misunderstand me here. I am not saying that no one should buy a home, or that my example scenario is a golden standard of truth for all. Don’t take my word for it. Run the numbers for yourself, check out other articles (a small collection is listed below), and do what works for you. I highly recommend the great graphical calculator from The New York Times for comparing the financial aspects of renting and buying. Many people will consider all of the consequences—financial, emotional, etc.—and conclude that buying a home is the best decision. Just don’t trick yourself into thinking it’s a good financial decision if it’s not.
I myself intend to buy a house some day. However when that day comes, I will be buying a house because I want a nice, “permanent” place to live where I’m the boss, not because I think it will help me get me rich.
Additional Resources:
Wall Street Journal: Your Home Isn’t the Nest Egg That You May Think It Is
New York Times: A Word of Advice During a Housing Slump: Rent
New York Times: Is it better to buy or rent? (graphical calculator)
The Motley Fool: The Worst Investment Ever
SmartMoney.com: Renting Makes More Financial Sense Than Homeownership
CNN Money: Stocks vs. Real Estate
Priced Out Forever: Renting vs. Purchasing
00
Hyperbola,
I’m not skewing the rent escalation data. I’ve been in this business for many, many years and 5% per year average rent escalation is historically accurate. Rents tend to outpace inflation by a little bit, though the model I used for my calculations assumes rent escalation and inflation at par (along with home appreciation — all three set equally).
Part of the false assumption you are making is that the opportunity cost for the homeowner is 8% after-tax annual returns in the stock market. That’s a gross misrepresentation of how opportunity cost and risk calculations work. The opportunity cost of the home owner’s decision is the 30-year long bond rate, since that’s the equivalent low-risk alternative for the time horizon. If the time horizon is shorter, it would shorter bonds, T-bills, or something like that. The stock market has a much higher risk profile than either bonds or owning a home, so you can’t use it for opportunity cost without skewing the result. You’d have to discount the stock returns so much for risk that the numbers wouldn’t make a lot of sense.
The other thing you’re failing to take into account is the divergent nature of mortgage interest versus escalating rent over time. The mortgagee is paying less and less interest every year, while the renter is paying more and more rent every year. After a few years, that divergence gets rather extreme, to the point where the amount of rent paid out by the renter over thirty years far exceeds the amount the home owner paid in both principal and interest.
If we assume 5% inflation, 5% rent escalation, 5% capital appreciation, and 6% opportunity cost (so that the home and rents are keeping exact pace with inflation with no real increases in value, and opportunity cost is slightly outpacing all of them just as it does in real life), the monthly rental rate will exceed the home owners cost of ownership (interest, taxes, maintenance, and all that other stuff) by the end of year 8 as I said earlier. The rent keeps going up, while the home owner’s cost of ownership declines. The differential is serious enough that even with compounding of interest on the renter’s initial savings, the renter’s equity peaks out in year 15 and starts declining to the point where by the end of year thirty it’s right back to where it started in year zero, while at the same time the renter has paid rent in excess of twice the amount the home owner has paid in ownership costs. Yet, the home owner also has the built-up equity of the home at the end of that period, while the renter does not.
I even give the renter the benefit of the doubt in all that by assuming he doesn’t have to move every two to four years.
It also looks like you’re treating principal payments on a mortgage as negative cash flow, when in fact they’re positive cash flow to equity. That’s an easy accounting mistake to make, but it can mess up your results by a lot.
Again, that’s why you’ll see lots of rich homeowners and very few rich renters. If what you were saying was true, it would be the other way around. The math and reality both back up what I’m saying here.
And, just for background, I used to believe exactly what you all are saying about renting vs. owning and lived by that belief. I rented for many years and banked the difference in investment accounts (which is the key part of the strategy…and the part most people don’t do). I noticed the differentials I’m talking about not just in the numbers but in practice. After 8 years or so, I fell behind. So I analyzed the situation in more detail and changed strategies when I discovered how wrong I was. I’m not saying that changing conditions might not get me to change my mind again, but for that to happen opportunity cost would have to go much higher than it is, capital appreciation rates would have to go negative for a decade, and rents would have to stagnate or decline. Right now, opportunity cost and interest rates are low, capital appreciation is stagnant or rising only slightly, and rents are escalating rapidly (get ready for rental rates upwards of $2 per square foot, coming soon to a neighborhood near you). This is my business. I know how the math works.
Rate this comment:
0 
0
So Tim,
I’ve looked at your spreadsheet, and you’ve made two errors:
1) Your assumption of 11% opportunity cost is way out of whack with standard financial practice for calculating same. I don’t know how you came up with that number, but opportunity cost / risk premiums for the purpose of discounting should always be based on the lowest-risk investment of similar term. In the case of real estate, that’s always the US Treasury instrument of similar period…usually the long bond. So, actually, your renter’s returns are going to be compounding at a much lower rate than you’ve assumed for the purposes of analysis.
2) You neglected to factor the additional cost of rent back into the renter’s tabulation of value. In your spreadsheet, the home owner paid out about $667K over the period of analysis. The Renter paid out $1,876K over the same period. The difference has to be factored back in. Either the home owner gets an equity credit to his own compounding savings account for having saved the extra $1.2 million not paid in rent, or the renter has to pay the extra out of his compounding equity as it comes due (that’s the way I calculated it). Either way, the home owner is going to way outstrip the renter again when you aren’t giving the renter a free pass on his negative cash flows.
Rate this comment:
0 
0
Again, that’s why you’ll see lots of rich homeowners and very few rich renters.
The only thing that proves is home owners generally have better paying jobs than renters.
I’m not saying that changing conditions might not get me to change my mind again, but for that to happen opportunity cost would have to go much higher than it is, capital appreciation rates would have to go negative for a decade, and rents would have to stagnate or decline.
That’s what happened in Japan after their housing bust. Years of declining home prices. They decreased their rates to 0%.
Many people in other parts of the country are finding out their homes are worth 20%, 30% less than a year or two before. The math is not working out for them.
Rate this comment:
0 
0
Worthy article with caveat that onen cannot take his “downpayment” or any percentage of it, and pop it into an 8% account. No such thing. Maybe… 5%. 8% doubles every 9 years. 5% doubles every 14. Not counting for now the substantial hit of paying taxes on all that interest during a 30 year run up, the 80k deposit placed instead in the bank at 5% will grow to about $350k- way less after taxes paid each year of run up. At 8% 80k will grown in 30 years to 700k or so, save that lots will be lost to taxes along the way. I suppose a tax free Muni Bond could help with the taxes, but i fear that Municipalities will be going BK due to the bubble effect, so they are not wholly safe.
Still, the principles you outline are sound and worth hearing.
e.d.
Rate this comment:
0 
0
I just looked at Tim’s spreadsheet and have to agree that the 11% return on the rental cash flow would defy almost any conventional analysis norm. Personally,I would use about 5% (risk free) for short-term considerations, and maybe 7% for longer term projections. Maybe 8%. Most finance minds would not project an equity risk premium beyond 3%, despite the roughly 4-5% of the last century, At the same time, I would put rent and home appreciation at he same growth rate. Except for anomalous times like now, both home ownership (prices being set by ability of these homes to change hands) and renting will inevitably be tied to income growth. One might assume that higher income people will see bigger % increases than lower income people, and that higher income people are the home buyers.
Rate this comment:
0 
0
Another way of looking at 11% assuned returns – this assumption would make any investment analysis nearly unbeatable in the long term. It just overwhelms all the other numbers in the analysis. The good thing is that anyone can input their own assumptions and look at the result, But the 11% would have to be a stated KEY assumption if the net result of the analysis was published.
The only thing that seems like a fixed, good assumption in this could is that tuition at our public universities will rise an average of 7% annually in the long run.
Rate this comment:
0 
0
I need to put my contact lenses in – sorry for the typos. Also, “in this world” not “in this could”
Rate this comment:
0 
0
gregory wharton said: the monthly rental rate will exceed the home owners cost of ownership (interest, taxes, maintenance, and all that other stuff) by the end of year 8 as I said earlier. The rent keeps going up, while the home owner’s cost of ownership declines.
I did not dispute this. It’s true – the interest cost declines over time to zero. This effect is partially offset by rising tax, insurance, and maintenance costs.
The differential is serious enough that even with compounding of interest on the renter’s initial savings, the renter’s equity peaks out in year 15 and starts declining to the point where by the end of year thirty it’s right back to where it started in year zero…
No, here is where your calculations are completely wrong. Both the renter and owner are taking in income every month, and in general this income rises at the same rate as rent (and, in the longer term, house prices).
Your assertion that the renter’s equity would ever decline in this scenario is wrong. The renter is NOT paying the rent out of his investment gains – he’s paying rent from his wages. So he gets the full stock market return, in addition to depositing excess wages every month. This does not change as prices rise, even though it’s true the owner’s costs may be declining.
I think you are getting confused between absolute savings and the relative comparison of savings between owners and renters. You cannot simply say, “the renter’s costs are more, so his equity is declining relative to the owner” because you are ignoring investment gains on the rest of the money the renter previously saved. Try caluating everything in absolute terms “renter saves $1000, owner saves $1400″ instead of “renter loses $1400″.
… while at the same time the renter has paid rent in excess of twice the amount the home owner has paid in ownership costs. Yet, the home owner also has the built-up equity of the home at the end of that period, while the renter does not.
As I have shown above, this is false. Both the renter and owner are building equity using different means.
It sounds like you are claiming that it is impossible (given the numbers in above) to build any wealth without buying a house. This kind of claim is ridiculous, and if you think it’s true in your life experience, either you’re getting a raw deal or you miscalculated.
To summarize, here are my claims:
a) In the current price environment, renters will initially be saving money each month by renting instead of buying the same house.
b) If rents, houses, and income all increase in price at the same rate (inflation or slightly above), both the owner and renter will have more money left over each year for savings. Neither will ever have to draw down this savings. This is easy to prove – if my rent goes up 5% from $1000 to $1050, and my income goes up 5% from $3000 to $3150, and all my other expenses go up 5%, then my amount of income left over for savings will also rise 5%. I will not be REDUCING my equity, ever. And that equity I have been saving all this time is still growing (whether it’s 6%, or 7%, or 8% is not important, as long as it’s higher than house price growth).
c) Whoever has the highest rate of return on their assets will eventually end up with the most equity. What the proper return rates are is completely debatable – though I would argue it is not proper to assume anything less than 6-7% for stocks.
Rate this comment:
0 
0
Typo.. “renter loses $1400″ —> “renter loses $400″
Rate this comment:
0 
0
Here’s a scenario to run through all your calculators:
– Run the the rent vs. own calculation through with whatever set of assumptions you want.
– Now run it through again, but change one thing: Instead of assuming a constant average appreciation for a home, run a scenario where the value of the home goes down for the first three years (by say – 10%) and then goes up by the same average.
Now see if in the second case, you aren’t better off renting for the first three years and buying the home for a lower price.
The general case is about as solvable as the superman vs. spiderman argument I joked about earlier. You can tweak a model just about any way you want with your assumptions. But I never thought this blog was about owning a home being a bad investment. I bet most of the people who are arguing on the side of renting are planning to buy at some point (even Tim)
I think the more relevant question is, should I buy now, or should I buy later? Everything else held constant in whatever model one chooses, with whatever set of assumptions one chooses – I don’t think there’d be too many scenarios where a few years of 2-5% per annum declines at the front end wouldn’t mean spending those years renting makes it a better outcome.
Of course, if one spent 2002-2006 renting and waiting for prices to come down, then I also doubt one will ever do as well as if they’d bought at the front end. But that’s because I don’t think the market will ever give back all the gains of the bubble. I know others do – and those opinions are equally valid. I just don’t happen to share the view. But overall I think the arguments about the general case of buying vs. renting comparisions are a pretty tiresome theoretical exercise.
Rate this comment:
0 
0
deejoyah,
Certainly, if you can time the market accurately enough to rent for three years, buy at a trough in prices, and then start on the equity train, you’d do better than someone who buys now. Both of them would beat the person who rents for the next 15 years, though. Even the buyer who takes three years of price depreciation before the market returns to historic trends. Personally, I don’t know anybody who’s any good at timing real estate markets. Not even my clients who have made hundreds of millions of dollars doing real estate investment will claim that.
Rate this comment:
0 
0
Hyperbola,
Now you’re willfully ignoring some basic requirements of financial math. If the income figures stay equivalent as you claim (and which I’ve assumed), the home owner is still paying way less than the renter every period starting in about year four or five. That money saved should be compounded in the same equity savings you’re computing for the renter. You can either create an account in your model for the home owner to bank and compound that saved equity (in which case, he gains all the same benefits you are currently accruing one-sidedly to the renter), or it has to be deducted from the renter’s equity every period to cover the difference. That’s the only way to truly compare the cost of one decision vs. the other. If you leave that out, your model doesn’t compare anything to anything.
Rate this comment:
0 
0
gregory wharton said,
Correlation is not the same as causation, Gregory.
11% was not used for this post. That’s just the value that happened to be in the spreadsheet, since it was originally created using Rhonda’s numbers, quoted in the post I referenced. You’ll notice the house price and rent are not the same as what’s in this post either. I used that spreadsheet to calculate this post, but I didn’t use the values that are uploaded in it at the moment.
I’ve read this a couple of times, and I can’t figure out what you’re trying to get at here. The “cumulative cost” for the renter is the total amount they have paid out that they will never get back. Rent, insurance, utilities, and tax on the interest building in their investment. For the owner it is Interest + Taxes + Insurance + Utilities + Maintenance + PMI + HOA – Principal – Tax Savings. How does this not account for the difference in amount paid out? I don’t see the “negative cash flows.”
Please elaborate.
Rate this comment:
0 
0
Tim,
During the period you analyzed, the home owner paid out $667,000. The Renter paid out $1,876,000 for the same thing (putting a roof over his head. That extra money (about $1.2 million) had come from somewhere. There are two ways to figure that difference in expense. One, both of their salaries kept increasing and they paid it out of income. If that’s the case, then the home owner had LOTS of extra disposable income that the renter didn’t have, and to be fair in the analysis, we’d have to assume that he invested it in exactly the same way the renter invested his initial savings on rent.
Two, you could simply take the extra expense of rent out of the renter’s equity in every period that the renter’s housing cost exceeded the home owner’s housing cost (which will be nearly every monthly period after about year 8).
Either way, the net effect is the same. The analysis you’re using is shorting the home owner $1.2 million plus interest that they ought to have, or crediting the renter with $1.2 million plus interest that they shouldn’t have. In both cases, since the difference in their equity at the end of the analysis you linked me to is about $1 million, the difference is enough to push the home owner ahead if you counted it, which you should.
Rate this comment:
0 
0
gregory wharton said: You can either create an account in your model for the home owner to bank and compound that saved equity (in which case, he gains all the same benefits you are currently accruing one-sidedly to the renter), or it has to be deducted from the renter’s equity every period to cover the difference.
Yes. We’re actually arguing for the same thing. I believe you’ve misinterpreted the results you get by doing this. Hence my suggestion that you use the absolute method (creating accounts for both owner and renter and compounding separately) rather than the relative method (creating one account representing the renter’s savings edge).
Here is my interpretation of your calculations and what I believe it means:
The initial own/rent decision is made using the assumption of initial savings as just enough to cover a 20% down payment. This is important because the debt ratio for the owner is really what controls whether buying or renting is cheaper, and this ratio goes down over time for the owner. If the renter’s savings grows fast enough, his debt ratio (if he bought later) would also decline. If the renter’s equity grows faster than the owner’s (as we all know it does in the beginning), then by waiting some amount of time, the renter can get a smaller debt ratio on the same house.
You said the cash flow advantage turns to the owner after 8 years. I think it’s likely to be longer than this, but it will happen eventually. Let’s assume this is a good number.
You said the renter’s equity advantage over the owner starts shrinking after 15 years. Again, I think this is reasonable, but it depends greatly on your individual situation.
Your futher claims about what happens after that are more suspect but I am not interested in debating those right now.
Now I will claim that really what you have shown here is that, using these numbers, the renter wins by buying the house from its current owner at the point of maximum equity advantage, which occurs around 15 years after having the 20% down saved.
I don’t actually need more specific data to claim this, but it would be helpful to run the numbers and see how much saved equity both sides have after 15 years (in absolute terms). Then we would know what the renter’s ownership cost would be by buying at that time. But even without this, we know the cost will be less than the person who bought the same house with the same savings 15 years earlier, because the renter has more equity!
So, from a common sense standpoint, the best approach here is to pick the house you want to purchase, then save to the point of maximum equity advantage, and then buy once the debt costs for that house are so cheap that you increase your equity faster by buying. This is a perfectly rational way of justifying the purchase of a house, and it sounds like you have personally done something like this (it sounds like you waited 8 years, not 15, but you still did the right thing by waiting, assuming you bought the house you could have bought at the beginning with 20% down!)
Now the final monkey wrench: as we renters wait, we tend to set our sights on bigger houses. We tend NOT to buy down our debt in the smaller house over those first 15 years while we still have an advantage – instead, we end up saving for a 20% or less down payment on a bigger house, which sends this math exercise around all over again, since we are now at 80% debt all over again!
To paraphrase: in the current environment, buying a house with 20% down is a poor financial decision compared to renting the same house. Buying a house with a large (TBD) down payment is a good financial decision compared to renting the same house. Are we in agreement now?
Rate this comment:
0 
0
Gregory,
Maybe you could send Tim the spreadsheet you used for your calculations. I am sure he would be happy to post it. Then we can all either learn from it or pick it into shreds.
Rate this comment:
0 
0
I think that the point of this blog, isn’t it? a discussion of whether real estate prices will continue to rise or bust?
I’d agree that normally it’s a fools game to time the RE market – but it seems its pretty blatantly obvious to most at this point that we are headed for depreciation, isn’t it? Lets look at the facts. The rest of the country is already going depreciating. Odds of a recessionare increasing and unemployment is rising. YoY appreciation in seattle is down every month, following the same pattern as every other market in the nation (95% of which have gone negative). Loose financing has disappeared. Inventory is up 50% and sales are off 25%. Personally, I see a pattern that makes the timing decision pretty easy. The only question is how long and how deep
Rate this comment:
0 
0
I’ve cleaned up and uploaded the spreadsheet I’ve been using here (http://files-upload.com/files/507074/rent vs own.xls). You can take a look at it yourself. To make the calculation it’s doing a bit more transparent, I’ve changed it so that it’s not deducting the renter’s increased housing costs from the renters equity, but saving the difference to a compounding investment account just like the renter has.
As you look at this spreadsheet, notice that at the baseline case of no appreciation or rent escalation above inflation, and an investment rate in line with real opportunity cost and not some pie-in-the-sky wish about infinite low-risk returns on savings, the renter never is ahead of the owner on equity. Not even in year 1.
Rate this comment:
0 
0
For some reason, this didn’t show up the first time I posted it. Here it is again.
This is the spreadsheet I’ve been working off of, modified so that it is now crediting savings on rent to the homeowner’s own investment account, rather than deducting them from the renter’s equity.
http://files-upload.com/files/507074/rent vs own.xls
If you play around with this, you’ll find that the only way the renter gets ahead of the owner in equity, even in year 1, is if the renter is getting real rates of return more than five percentage points higher than historical averages or standard financial accounting practice allows you to assume and the homeowner is getting no capital appreciation at all.
Rate this comment:
0 
0
Greg, what do you think about the NYTimes buy vs. rent calculator? What kind of numbers do you plug in?
Rate this comment:
0 
0
Gregory,
I think I am misunderstanding you. Are you taking the rent I pay as a renter and adding it to your interest earning account as an owner even though I’m not paying the money to you?
Rate this comment:
0 
0
I can’t seem to download this file… Excel (2000) claims there is a problem with it.
In any case, I think the spreadsheet itself is suspect based on your last comment, but I am waiting to see the details. :)
Rate this comment:
0 
0
Okay, got the file open on my Vista machine. :)
Some issues I found:
1) Principal is added to net equity without being included as a cost. The renter is not paying principal, but the owner is. That’s a $350 error per month right there.
2) Property tax around here is more like 1.25% APR.
3) Income tax should be 28% for most people. This is the marginal tax rate for most middle-class homebuyers.
4) You haven’t given the renter a standard deduction. For married couples, this is over $10k per year off taxable income, which results in a tax savings of about $233 per month in favor of the renter (depends on circumstances).
5) Renter’s insurance is too high. For me, it is 0.01 times my rent.
6) Maintenance is too low. A good figure is 0.01. Should be $400-500 a month instead of $200.
7) Property tax is too low for this location. Should be 1.25-1.3%.
8) You haven’t calculated post-sale equity. Whether this is appropriate or not just depends. If you want to know who wins after the owner buys and then sells, you need to take 7% (more, actually) off the sale price. If you want to know who wins after the renter buys several years later, it’s probably okay to ignore this.
I believe the collective sum of these errors swings the balance quite significantly.
Rate this comment:
0 
0
Alan,
No. I’m doing a true comparison. That means that in any period in which the renter pays less than the homeowner in housing costs, the renter banks the difference in an interest-bearing account. In any period in which the homeowner pays less than the renter, the homeowner banks the difference in an interest-bearing account. That’s pretty simple, and that’s how it ought to be calculated.
Rate this comment:
0 
0
Hyperbola,
Now your just yanking my chain rather than making substantive critiques. To address your “issues”, let take a shot:
1) The principal payment part of your mortgage is not an expense. That’s accounting 101. It’s a payment direct to equity, just as any savings the renter makes to an interest-bearing account are direct-to-equity payments. You have to treat them exactly the same because they are the same.
2) The property tax difference you’re citing isn’t large enough to make a difference. Change the figures and you’ll see what I mean. You could make the property tax 3% and it still wouldn’t make any difference.
3) The income tax figure is also largely irrelevant. If you increase the tax rate, the owner’s advantage only grows. Go ahead.
4) The standard deduction is generally a wash for itemized deductions not including mortgage interest for many (most) homeowners (it is for me). Again, standard accounting practice is to count cash flows from tax shelter as a positive payment to equity. That’s exactly what I’m doing here.
5) Go ahead and change the renter’s insurance rate. In either case, it’s so small that it’s just chump change. It doesn’t modify the analysis in any substantive way.
6) 1% of value for maintenance costs is way too high. I don’t know any homeowner who pays anything close to that amount in maintenance costs, even if you amortize out things like unblocking a sewer pipe every five to ten years. From you comment about this, I have to wonder if you’ve ever actually owned a home or if you’re just punting on this one.
7) Again, the property tax rate difference you’re talking about is so small as to be negligible. Go ahead and change it. It won’t make much difference at all.
At the bottom of the spreadsheet, you will clearly see where cost-of-sale is subtracted from the home equity value before tabulating net equity. You must have missed that part when you were looking at it. Go ahead and change the cost-of-sale to 10% if you want to. It’s doesn’t make much difference.
Just for laughs, I went and put the changed figures you suggested into the model to look at them. I’m not going to change things that would be directly contrary to standard financial practice, so you’ll have to keep counting equity as expense on your own time.
The results are as follows:
Renter – Net Equity at End of Year 30: $826,708.34
Owner – Net Equity at End of Year 30: $1,928,437.18
The renter is still underwater by more than a million bucks.
Rate this comment:
0 
0
I agree that everything except (1) and (4) are minor points. I included them for completeness’ sake.
(1) You are wrong on this one. The actual cost you are paying is interest AND principal, and in return for that your equity in the property goes up. You have factored in the second part (adding principal paid to net equity), but not the first. You are effectively paying yourself, but you still have to shell out the principal amount every month, while the renter doesn’t. So in effect your spreadsheet has double-counted the benefit of principal pay-downs.
Here is the issue: your actual (approximate) costs total $2100 plus $350 for principal, plus $400 for maintenance. The renter only pays $1600. The net effect of this is the owner pays $1250 more per month in cash flows, and at the same time, the owner’s equity in the property goes up $350.
(4) You’re missing the point. The owner gets to itemize the interest he pays, which provides a tax benefit (if done correctly on his W4′s, he gets this back every month, not once a year). The renter gets to use the standard deduction, which you haven’t included here. You’ve effectively assumed that the renter gets no tax benefit when this is usually wrong.
Rate this comment:
0 
0
Hyperbola,
It’s not my job to teach you the fundamentals of real estate finance. If you’re really interested, go and find some books on the subject. In them, you’ll find that they treat payments of principal EXACTLY the way I have treated them: as equity build-up. The layperson only looks at the amount of the monthly payment and doesn’t understand the accounting principles behind what goes where and how it should all be tracked. I am not a layperson on this subject, so you’re not going to convince me to treat an equity transfer as anything except an equity transfer.
Now, on the tax subject, I acknowledge that the handling of tax deductions is a complex subject. In fact, there’s really not any good way to handle it beyond looking at each individual person’s situation. What I did was a work-around: there is definitely a direct net positive cash flow from tax shelter due to mortgage interest and property tax deductions. The home owner has benefit of that, and the renter doesn’t. Apart from that, the renter can claim the standard deduction, but the home owner can also claim lots of other itemized deductions that in practice often come out roughly equal to the standard deduction not even counting mortgage interest and property tax deductions (last year, my non-home-related itemized deductions were well in excess of the standard deduction, for which I thank my accountant and his voodoo-working machinations). There’s no good way to really allot them in a generic model. You can’t just say that the renter gets the standard deduction and the homeowner gets only the mortgage interest and property tax deduction. That’s just silly. Does the renter’s standard deduction mean in practice that the home owner’s tax shelter value is less by comparison in some cases? Probably. However, like with the other items, the difference is so small we can ignore it without worrying about skewing the model over-much. You’ll notice that to account for that, I’ve also pushed the tax issues related to the renter’s investment activity out to the end of 30 years as a tax-deferred account. In practice, it really wouldn’t work that way, but it’s to the renter’s benefit to simplify it in this manner so it all balances out.
Rate this comment:
0 
0
gregory wharton said,
Okay, I think I see the problem here. Part me, part you.
My problem is that the “Cumulative Cost” columns took some things into account that they shouldn’t have. For the renter, it doesn’t make sense to add the tax on their interest earned to the cumulative cost, since that is more like unrealized gain, coming directly out of the interest earned. For the owner, it doesn’t make sense to subtract principal paid from the cumulative cost, since that is accounted for separately in the ongoing calculation of equity in the house. When I make these corrections in the spreadsheet (with the values as downloaded, which we both agree aren’t necessarily reflective of a realistic scenario) the difference is much more minor, with a cumulative cost of $1.21 million for the renter, and $1.07 for the buyer.
Your problem is that you’re misinterpreting what the “cumulative cost” field is telling you. It’s really just included as a point of interest. What you should be looking at is the “monthly cost” columns. You’ll notice that even in year 30, the home buyer is paying $5,340 to the renter’s $4,988, resulting in a monthly savings of $352 that the renter is able to add to their investment.
If the values in the top section are changed such that the renter’s monthly costs begin to exceed the buyer’s at some point (for instance, change “inflation” to 5%, and it happens in year 16), the spreadsheet begins to take this monthly difference out of the renter’s investment. The basic assumption is that the renter and buyer are both making their monthly payments out of income at the start, and their incomes grow equally at whatever rate would be necessary to make the buyer’s payments on the house. Therefore, if the renter’s costs begin to exceed the buyer, they start to deplete their investment.
Hope that clears things up.
Rate this comment:
0 
0
I’m looking at the spreadsheet and I don’t know what an “escalation rate” is. Could someone explain this to me?
Rate this comment:
0 
0
I see Tim agrees with me on the principal payment issue. I didn’t even notice the issue with tax on interest.
I agree that taxes are complex. However, in my experience, MOST people do not have $10k in itemized deductions before interest. So you have an advantage over many people because you get the full value from deducting your interest.
I respectfully ask that you stick to the facts at hand instead of bashing me. I am not an accountant, but you are still wrong on this one. Effectively what you have done is to have the owner’s principal paid by the renter in your calculations, but the relative way you account for things makes this difficult to see.
Let’s use a simpler example: assume the only expense is the owner’s principal payment (there is no rent, interest, or appreciation, so “net costs” for everybody are zero). Both owner and renter have $1000 income and the owner has a $10000 loan on a $10000 asset. Both start with zero equity.
The renter has no costs and $1000 net savings, resulting in $1000 equity.
The owner takes his income and writes a $1000 check to the bank for principal. The loan balance declines by $1000. So the owner has total costs of $1000, no savings, and a resulting equity of $1000.
Here is how your spreadsheet accounts for this (try it and see): you show a net cost of $0 for the owner, since he paid himself. Since both sides have a net cost of zero, you show no cash flow advantage for the renter. You show a savings deposit of $0 for the renter. You calculate the owner’s equity as $1000 and the renter’s equity as $0.
Do you see the error now? You need to compare actual payments, not “net” costs. You’ve taken the owner’s principal payment out of what should be the renter’s savings! Even though principal isn’t a “net cost” to the owner, it is still a $1000 cost the renter doesn’t pay. This is why I recommended using absolute savings figures instead of a relative savings account for the renter. These kinds of errors are much easier to spot.
Rate this comment:
0 
0
Okay. I think I see where the misunderstanding is here, and the answer is that we’re both right. On the one hand, payments to principal really are equity transfers and should never be counted as equivalent to rent. They’re not an expense in an accounting sense, while both rent and interest payments are expenses, and that’s what should be compared when looking at rent vs. mortgage payments.
On the other hand, you are looking specifically at the case where all capital flows are coming from personal income rather than holistically at a personal total balance sheet. That’s fair. So, I’ve re-calculated the spreadsheet to include principal payments as costs of housing from income. You can find the revised spreadsheet here:
http://files-upload.com/files/508508/rentvsown2.xls
Now, by including the principal as a direct housing expense and crediting the renter for that amount in savings, the renter’s equity certainly goes up. However, you will notice that in the case where we assume that home appreciation and rental escalation stay at the inflation rate and opportunity cost is at the long bond rate, the home owner still comes out ahead. With a home value of $490,000, rent of $1600, inflation-appreciation-escalation at 4% (equivalent, so a wash), and opportunity cost (the investment return rate) at 5% (the long bond), we get the following at the end of 30 years:
Renter (Net Equity): $978,577.90
Owner (Net Equity): $1,687,186.08
So, after ALL that, the home owner still comes out ahead.
If we look at the more realistic case where real appreciation on the home is 1.5% over inflation and rent escalation is more like 1% over inflation, the divergence grows:
Renter: $1,016,352.55
Owner: $2,545,378.96
Conversely, let’s assume that the home is not keeping pace with inflation (appreciating at 2%, rather than our assumed 4% inflation rate). If rent escalation stays at the inflation rate (which is typical historically), then the owner STILL comes out ahead:
Renter: $865,629.26
Owner: $1,177,139.85
Now, as a final case, let’s assume that real estate values plateau for thirty years and the owner gets no home appreciation at all. If rents continue to escalate at the inflation rate, the home owner wins:
Renter: $802,089.51
Owner: $919,712.52
If rents don’t escalate at all, then the renter comes out ahead:
Renter: $1,304,720.92
Owner: $657,834.24
Now, since housing costs are typically 30% of gross salary, that means in all these cases we are assuming one of two things for the renter:
A) The renter is saving something on the order of 22.5% of their gross pay every month (is there anybody reading this who even comes close to saving that much of their gross salary?), or,
B) The renter is living way, way, way below their means.
People make all kinds of lifestyle choices, and I’m very much in favor of living below my means myself. That’s the only way to really build wealth, regardless of whether you own a home or rent. But let’s be honest about this: a $1,600 rental house is not directly equivalent to a $490,000 owned house. I’ve done both, and even the nicest rental is still not up the level of quality of a house you own and keep up. Rentals take a real beating and wear out fast. You’re not going to find a nice one with that much of a price differential from a mortgage payment.
Plus, rents are jumping up right now. It’s not that unusual to find rental rates over $2.30 per square foot for apartments in the city now, and the analysts are projecting $3.00-plus rates coming in the next two years. Rents in Seattle have been stagnant for six or seven years now because all the housing demand has been focused on buying. Now that mortgage money isn’t cheap any more, rental rates are accelerating upward. Add to this the lack of rental unit supply, and you’ve got a difficult situation for renters, no matter what happens with housing prices.
None of which really constitutes a recommendation for one course of action or another. What it does mean, however, is that the issue is nowhere near as straightforward as the anti-ownership crowd has been making it out to be here. On the one hand, if you run the numbers using realistic figures and historic norms, the home owner will almost always come out ahead of the renter over time. In fact, the renter never gets ahead of the home owner even in year 1. However, if housing prices fall, renting could be a very good idea for a few years. On the other hand, if you’re going to try and time the markets that way, make sure you get a long-term lease (and get it notarized–leases over one year term aren’t valid unless notarized). That way, at least, you won’t get whipsawed by the major rent escalation that looks imminent.
Rate this comment:
0 
0
Okay, good, now we appear to be on the same page! Without poring over the spreadsheet some more, I can’t articulate exactly what Tim was objecting to regarding interest and taxes, but that might be something that needs fixing too.
Regarding some of your numbers: you have to be really careful about assumptions here. When analyzing short-term horizons (who wins after 1 year? 5 years?), adjusting for risk is difficult. Sure, you can use riskless (or nearly riskless) bonds for investments, but I’m not sure that’s appropriate – the annual log-normal implied volatility of indexes is usually 15% or more, which drowns any short-term profit you may receive. So for short horizons, it’s not even reasonable to put this money in stocks. Also, as I commented a long time ago, you also need to adjust for risk on the house, which is impractical.
It’s more practical to use a long-term horizon, like 30 years. In that case, short-term variations don’t matter and you should be using established historical norms. (Whether you should assume reversion to the mean given current departure from those norms is debatable.) House prices, historically, go up at the same rate as wages, about 1% over inflation. (Same for rent.) I don’t think it’s proper to assume prices will go up faster than rent long term – economic forces create arbitrages (like the rent vs. own discussion we’re having right now) when things temporarily diverge.
Historically, stocks gain 5% per year after inflation. (About 7-8% before.) The fact that this carries more short-term risk is irrelevant because both the owner and renter are holding on for 30 years no matter what. Of course, you should discount this a little due to the fact that most people don’t park their savings all in stocks – even people my age (24) should have 10% in bonds, depending. Now, if you still claim this needs to be discounted for risk, then fine, tell me what the risk (standard deviation or other measure) over a 30-year period is for stock indexes and an individual (nondiversified!) house and discount both.
My quick and dirty estimate says for stocks: e^(0.15 * sqrt(30)) = factor of 2.26 of risk over 30 years, which amounts to a risk adjustment of ~2.75% per year. So that means we can assume at least 5-2.75=2.25% per year appreciation for stocks after inflation. Now see if you can perform a similar risk adjustment for nondiversified house prices (I have no data for this. All I know is indexes have much lower implied volatility than individual stocks.)
I can offer some insight into my own circumstances as a renter. I live in a really nice apartment building downtown. The building is 6 years old, and here the rent/own cash flow discrepancies are even more out of whack than for single-family homes. My apartment would probably sell for total costs (as calculated above) 2.5 times the rent or more.
My household is upper middle class. We spend 17% of gross income on rent and parking. Including retirement accounts, we save over 25% of our gross pay. Sometimes 35% of gross.
We just got out of college 2 years ago, so from my perspective, it makes sense for us to wait to buy. Our savings is (for now) accumulating faster than the price changes in houses we plan to buy in a few years, even at 10% per year appreciation (which Seattle is not sustaining anymore). Eventually, this will no longer be true – either we will raise our price range to the point that the same appreciation rate starts to outgrow our savings, or the borrowing cost of the house we want will be lowered by having a big down payment saved. At that point, it will make sense for us to buy.
Rate this comment:
0 
0
Hyperbola said,
I was referring to my own spreadsheet, and the “cumulative cost” column on it. There was however no effect on the month-to-month cash outlay.
Gregory,
I am curious, as a poster above asked, what you think of the New York Times Rent-vs-Buy calculator. When I punch in the same set of assumptions into their calculator as my own, I get similar results. Would you care to comment on that tool?
Rate this comment:
0 
0
Hyperbola,
As a younger person, you certainly have a higher risk tolerance, but for the purposes of financial analysis, you can’t use the stock market as your opportunity cost rate without crediting the home owner for having a much lower risk profile, both long- and short-term.
Volatility in the stock market tends to be a lot higher than in the housing market, even over 30 years, and even index funds can’t really protect you from that. If, for example, you bought into the stock market in, say, 1929 and held on for 30 years, you wouldn’t even beat inflation. With stocks, timing is everything. That’s why they’re a lot more risky than houses or bonds and no financial analyst would consider the risk factors associated with stocks to be equivalent to real estate. For one thing, the stock market is a lot more prone to Black Swans than the real estate market is.
Rate this comment:
0 
0
Tim,
Since that calculator is a black box, I can’t really comment on the sorts of results it generates. It’s not at all clear how they’re calculating those numbers.
I do know from looking at the spreadsheet you were using vs. the one I am using that your comparison is one-sided in favor of the renter since monthly cost-plus-savings is not equal for the owner and renter in every period. My spreadsheet adjust the numbers so that the total of housing cost plus savings is equal for the owner and renter in every period, regardless of who has the higher housing cost. That seems to me to be the only way to reasonably compare the two. The spreadsheet you showed me equalizes them for the renter so long as the rent is less than the housing costs of the owner, but doesn’t reverse when it goes the other way (which it does in later years).
Rate this comment:
0 
0
a $1,600 rental house is not directly equivalent to a $490,000 owned house
The last rental I was in was $1800/month and would have sold for $700k easily.
I’m not anti-home-ownership. Before moving the the Puget Sound I owner my own home for 9 years. Looking back at my calculations I broke even owning versus renting, but I really do like the fixed payments a mortgage gives me. I also like the security of controlling when I move. Taking into account emotional factors I came out ahead even though financially I broke even.
I am anti-home-owning in this location at this time. I’m expecting a 30% drop in home values over the next few years. I can’t make the ownership vs rental calculations work. My wife and I sometimes talk about “what if” we had bought here three or four years ago. Would we see this bubble as it is, sell our house, invest the equity and rent until prices dropped? We say that we hope we would, but we also acknowledge that we might be blinded by the appreciation.
We also run scenarios where I had made large profits in the two homes I have owned. Had I purchased in a different neighborhood in Raleigh, I could have made a $100k profit instead of $10k. I could have taken that to Austin and used it to purchase a larger home in a nicer neighborhood there and turned it into $250k (instead of selling for $3k above the purchase 5 years previous — and that is before real estate commission). Then I could have moved here with the expectation that real estate always goes up and dumped my equity train money into a $500k house which would be worth close to $550k today.
If prices do drop 30% that would take my hypothetical purchase back down to $385 and my equity train balance to $135k. But maybe I would get unlucky here and choose a neighborhood that drops more than 30% or I leverage myself more into a more expensive house (because that is how you make money I would have learned) and lose it all. Easy come, easy go.
Rate this comment:
0 
0
gregory wharton said,
I don’t know what you’re talking about, Gregory, because this statement is just flat-out incorrect. Monthly cost plus savings most definitely is the same for the owner and renter in every period. Just look at “Monthly Cost” plus “Saved/Mo.” for the renter, compared to “Monthly Cost” for the buyer. They’re equal every year.
If you plug in numbers such that the owner’s monthly costs are less than the renter, the “Saved/Mo.” figure for the renter turns negative (meaning the renter is now tapping into their investment), which still results in the figures being equal.
Rate this comment:
0 
0
I can’t say that I follow every accounting detail in this thread. Is it accurate to conclude that it is not good financial planning to buy real estate in a stagnant or declining market, especially for the short term? If so, I believe that was one of Tim’s points in his original post.
..
I am not anti-home ownership. I want to buy my own place some day. However, I am not going to buy real estate at the top / near the top of the market, as I believe that Seattle is lagging national trends and observable market correction is due. Even Mr. Greenspan said “…home prices have further to fall…” very recently, so there is a good chance that this ride isn’t nearly over.
..
Also, as DJO alluded to, with this kind of analysis it appears that there are so many variables / assumptions involved that any predictions that actually come close to reality are a result of luck more than anything else IMO.
..
Gregory Wharton said:
The renter is saving something on the order of 22.5% of their gross pay every month (is there anybody reading this who even comes close to saving that much of their gross salary?),
..
For what it’s worth, I save 29.0% of my gross income, excluding a mandatory 7.0% deduction for my retirement pension. I do live simply.
Rate this comment:
0 
0
Tim,
Take a close look at the spreadsheet I linked to. You’ll see what I’m talking about.
Rate this comment:
0 
0
anonymous,
1) If you’re going to live in a house for less than four years, it almost never makes sense to buy it. I’d consider that a “temporary” living arrangement, and much better suited to renting unless the market and location were in great shape.
2) People who get in the habit of trying to predict the future only wind up humiliating themselves over time. It’s a bad habit that I tried to give up many years ago. I don’t know what the housing market is going to do. Could prices drop 30%? Sure. More likely (based on previous RE cycles in this area), prices will remain stable but liquidity will vanish for a few years (which makes selling a bit dicey if you need to get out). Could prices continue to go up? Yes, that’s also possible. If you’re going to base all your decision-making on a prediction of the future, particularly with respect to financial markets, the only thing that is for sure is you will be disappointed. I’ve learned that the hard way.
3) I congratulate you on your ability to live beneath your means and save a substantial portion of your income. Most people can’t even muster 10% of their gross income in savings each year, let alone 29%.
Rate this comment:
0 
0
GREGORY WHARTON SAID….
“But let’s be honest about this: a $1,600 rental house is not directly equivalent to a $490,000 owned house.”
How about brand spanking new “luxury” downtown condos?
Rate this comment:
0 
0
A lot depends on the time horizon. If you look a 30 year time horizon, it is much harder to come up with a scenario that favors renting. On the other hand, if you assume that we are entering a period with below average home price appreciation — which seems a reasonable assumption — then it is very easy to construct a scenario where it is better to rent for the next several years. If prices appreciate at just 2% per year (not negative, just below average positive appreciation), then for the better part of a decade a renter will be ahead of an owner who needs/wants to sell, even if you assume rent increases of 7% per year. If they both continue to hold after that, then the owner eventually gets ahead, but the typical “bubble sitter” is looking at buying within 5-10 years, not renting forever.
Rate this comment:
0 
0
I agree that the stock indexes have higher long-term volatility than housing markets as a whole, but that’s not what we’re comparing here. We’re comparing the volatility of stock indexes to the volatility of a particular house. Not the same thing. But I think we already briefly discussed the benefits of diversification above – without specific data it’s hard to argue this one way or the other.
I’m not sure I agree a diversified stock portfolio is more vulnerable to Black Swans than real estate. All asset classes have unpredictable disruptions that cause losses, especially after adjusting for inflation.
According to http://w4.stern.nyu.edu/salomon/docs/Shiller_NYU2007.pdf, which may or may not be adjusted for inflation, if you bought a house in 1895 and held for 30 years, you would be even more screwed (down almost 50% in 1925) than stockholders who bought in 1929. I’m not sure where the data in that chart comes from, though.
All it would really take in any medium to large city for lots of people to lose everything is for the largest business in town to pull an Enron and go under due to massive “accounting irregularities”. The same risks apply to stocks. Presumably, most people think Seattle is very unlikely to experience such a disruption, but that’s why they call them Black Swans. :)
So the question of risk is not merely “how plausible is it bad things might happen?”, but also “how many bad things does it take before I panic and change my strategy?”.
Rate this comment:
0 
0
Here’s my real-world example. Wife and I bought a typical small Greenwood house in 1993 for $141k with a fixed rate 30 year mortgage. In 2002, we re-financed to 15 year loan, lower rate, and pulled out $20k for kitchen remodel. We made some extra principal payments along the way, mostly in the early years. Today, September 2007, we think Zillow is about right on the estimated sale price – $470k. Our principal balance is ~ $80k. With 9% cost of sale, we would net $348k. Our mortgage payments started at $1000 a month, and have risen to $1375/mo with increasing taxes and insurance, plus move to 15 year mortgage. In total, we’ve paid $225k over the years. Add to that about $55k in maintenance and improvements for total outflow of $280k. (Haven’t bothered to figure the tax deduction on the mortgage interest here, which would reduce the total payments.) If we sold today (if we were able…), we would get back every penny we’ve put into the house plus about $70k. In other words we would net out rent free for 14 years plus $70k in pocket.
In the early days of our mortgage, rent would have been cheaper than mortgage. We crossed over somewhere around 10 years into the deal. Now we think it would cost about $1800 /mo to rent this house.
Would we have been better off renting and investing the “savings”? Maybe. But remember that money in the stock market in 2000 didn’t recover its value until around 2005. Don’t completely dismiss the “forced savings plan” idea. Would a rental house have been in the same condition as we’ve kept our house? Doubtful.
Owning our house likely kept us from moving closer to my work, but ties to church and kids’ school now exert the same restraint. I live in and work out, so my reverse commute isn’t too bad.
It might not be this home, but one of these days, we will own our home and our monthly payment will be down to taxes (Ugghhh) and insurance, which today amount to about $380/mo. As “rent” goes, that’s a stellar deal.
An observation about appreciation: In 1938, when our house was built, the tax appraisal was $1200. In 1963, the tax appraisal was $2500. In 2006, the tax appraisal was $347000. In the early years of our mortgage, the house seemed to appreciate at about the mortgage interest rate (6 to 7%). Recently the numbers were much larger (17%). My own theory is that the tax change on exemption from capital gains tax on housing appreciation was nearly as important as low interest rates in causing the current bubble.
All for now.
Rate this comment:
0 
0
As a landlord and a current real estate investor (foreclosures @ 70% aquisition cost to current value) I agree that the value of rentals vs. purchase is the little known or believed secret. This is if you measure in economics only. A few examples that I can give are my own. We usually sell everything we buy rather than put it into our rental inventory because in a market that rose as fast as this market did it can decline with equal enthusiasm. We kept two $400K+ homes (one was $500K and one was $400K) because of tax purposes. The $400K home was advertized for $1695 per month but the renter opted for a lease purchase plan for more but the $500K (now worth $400K) is renting for $1795 per month. These are bargains compared to owning. Both of these homes had minor problems with the heating systems this year and guess who they called. While it may give you a warm feeling to own your own house it doesn’t give me a warm feeling to lose money. In the second example I gave you, I can assure you that $1795 was all the market would bare because it was not easy to get a renter. If they put the difference in cost of ownership and renting in a decent investment they can achieve wealth without buying a home beyond their means.
It used to be that a landlord could expect a rental to provide 1% per month rental compared to current value of the asset and if that rule of investment applied either home would bring $4000 a month. Those days disappeared a long time ago. If the landlord has lost this advantage who do you think now has this advantage? I did say “if measured in economics only”. We have a home that we purchased that we love and our children think of it as home. There is a value to that and it cannot be measured economically. I wish that for everyone.
Rate this comment:
0 
0
[...] mortgage to get. Personally, I would look into renting a nice house for at least a few years (see this post for a strictly financial comparison between renting and buying similar homes in the Seattle area). [...]
Rate this comment:
0 
0
[...] say you’re a prudent person who has compared the financial realities of buying vs. renting and made the decision to rent for now. However, with the frequent news reports about increasing [...]
Rate this comment:
0 
0
There is a mistake that rent-vs-buy articles make all the time. Including yours. In your rent vs buy cost table you said: Rent costs $1,495, while mortgage costs $2,093. Some of that $2,093 should be money that goes into your pocket since it is equity + interest. And the saving that goes to your pocket should increase through time not to mention the increase in property value
On the other hand, rent costs $1,495 only for the first year. If you decided to renew the lease, most likely it will increase.
Rate this comment:
0 
0
Swing Ninja, you did not read the post very carefully, because all those things were indeed considered.
Rate this comment:
0 
0
They were considered? Where? Is it that 20-year statement? What rate of rent increase are you using and what rate of inflation? Are my monthly contributions to this 8% account going down as my rent goes up? I’d like to see the calculations on that. But I would tend to think that the inflation-adjusted price of renting remains relatively the same over time while the mortgage goes down, down, down. Not to mention I’d LOVE to find that financial instrument you mention which guarantees an 8% return. The stock market? Well since we’re using historical averages, then from an admittedly cursory search, home prices around Seattle increase 7% historically. I’d much rather get a 7% return on $425,000 than 8% on this $85,000 (plus deposits) I have for a down payment. You’d have $300,000 in 10 years, I’d have about $425,000 in 10 years in just appreciation, not to mention my $85,000 downpayment and added equity from payments (which is admittedly small). Let’s just say I have $525,000 in net worth to use a semi-round number. Yes, yours is liquid, mine is not. But it’s my estimation that that’s always the problem in the U.S. Why does the government want to charge you a penalty for withdrawing funds from your 401k or IRA early? To make it relatively illiquid. If it’s all free and easy, why not just buy that boat, or those fancy trips every year. You’re describing a “perfect saver” which there are very few of in this world. I’m kinda anxious to run these numbers myself.
Rate this comment:
0 
0
Hi Bill,
As I said previously in this comment thread, the math behind this post was actually quite in-depth, I just kept the explanations to a minimum to avoid it becoming excessively boring and dry.
You can play with the numbers yourself by using either the spreadsheet I made (posted here), or for a more graphical and less tedious method, the New York Times calculator I mention in the post is quite useful and I’ve found it to be pretty accurate as well.
Best of luck to you.
Rate this comment:
0 
0
Hi Tim,
Well, your spreadsheet is very well done. I prefer things like spreadsheets to “black box” calculators. But I think we’re going down the route of having to agree to disagree. I think the assumptions you make of 11% return on the stock market and 4% appreciation are way out of whack. You’ve taken the most optimistic view of the stock market return and the least optimistic view of home appreciation. Simply ticking up the house appreciation 1 percentage point, from 4% to 5%, doesn’t make renting a good option until year 13. Even one more point and it skews completely in favor of owning.
And that article the spreadsheet is part of is laughable. Absolutely nothing is sourced and it uses the highest level of hyperbole. No matter how right or wrong it may be it simply cannot be taken as credible. Who the heck is this person? Why should I believe anything s/he has to say? Why is s/he writing this article? For all I know s/he is a landlord. Hmmm…negotiating 15% off my rent? Yeah, that’s common. Especially since renters have almost no rights in Seattle. And apparently home appreciation is not in the constitution, but the return on the stock market is. The “Bottom-Line” section shows this bias pretty easily. The only numbers that change are house appreciation percentages. I guess 11% return IS in the constitution! How about also comparing various returns from investing to the various returns on the stock market. People in their 40s or 50s that are much closer to retirement need to be more conservative in their investments than a 25 year old. The investment return should also go down over time because of the need to preserve capital at a certain age. The best part of the article is your spreadsheet as it allows folks to change the assumptions based on their personal situation and how averse they may or may not be to risk. The article itself is no better than any RE Agent saying it is ALWAYS better to buy. Never say always or never.
But I’ll just keep paying my mortgage and when it comes time to move on to a bigger and better place I’ll rent my old place out and get some nice positive cash flow out of the property. So keep on renting!! After all, I’ll need someone to occupy it.
Rate this comment:
0 
0
Bill, you seem to be fixed on the 11% thing. That number is in the spreadsheet by default only because it was the number thrown out there by Rhonda Porter, the lady who wrote the original article that the article on POF is responding to.
For the purposes of this post, I used a more conservative 8%, which is closer to the historic long-term average of stock indices. However, there’s a reason that it’s a configurable variable in the spreadsheet. The purpose of the spreadsheet isn’t to shove a particular set of numbers down anybody’s throat, but to provide a tool that people can use to compare their own unique situation.
Rate this comment:
0 
0
[...] at some Seattle-area rent vs. buy comparisons to see if the situation has improved at all since we analyized it last summer. Back then, the real-world example I used compared two similar homes in Kirkland. Total monthly [...]
Rate this comment:
0 
0