Longtime P-I real estate reporter Aubrey Cohen certainly knows how to get my attention. Here’s a story he ran on their site yesterday: Report finds buying a home way cheaper than renting
Buying a home is way cheaper than renting in all 100 of the nation’s largest metropolitan areas, including Seattle, according to a new report.
The average homeownership cost in the Seattle area is $978 a month, 42 percent lower than average rent, the real estate company Trulia reported. Nationwide, owning is 45 percent cheaper than renting.
It’s also worth noting that Trulia’s calculation factors in a range of expenses, including closing costs, maintenance, insurance, property taxes on the purchase side and security deposit and renters insurance on the rental side. It also assumes owners will keep a house for seven years and itemize their taxes, so they can take the mortgage interest deduction.
The claims being made here by Trulia do not pass the sniff test. Average Seattle monthly ownership cost of just $978? No stinking way.
Here’s Trulia’s page about the report. They go into a little more detail about how they arrived at these conclusions:
To calculate whether renting or buying costs less, we assume people can get a low mortgage rate of 3.5%, itemize their federal tax deductions and are in the 25% tax bracket, and will stay in their home for seven years.
…we estimated the total costs of renting and buying for the typical property in a metro over a seven-year period. We factored in all the costs of homeownership (e.g., closing costs, maintenance, insurance, taxes, etc.), along with the tax benefit of deducting mortgage interest and property taxes, as well as the proceeds from selling the home after seven years with modest home price appreciation. …Finally, we calculate the net-present-value of all those costs to capture the opportunity cost of tying your money up in a down payment.
I just so happen to have a convenient spreadsheet I designed to tackle nearly this exact same problem. I last posted data generated by this spreadsheet in July. Here’s a link to the spreadsheet so you can download it yourself. Let’s plug in some numbers.
The median price of a single-family home across King, Snohomish, and Pierce Counties was about $300,000 in August. Let’s use that as our baseline. With a purchase price of $300,000, a 20% down payment of $60,000, and an interest rate of 3.5%, your principal plus interest payment each month comes out to $1,078.
Add another $600 a year ($50/mo) for homeowner’s insurance and $3,450 a year ($288/mo) for property taxes, and your total PITI is up to $1,416. A standard estimate for home maintenance is 1% of the home’s purchase price annually, so add another $250 a month to bring us to $1,666.
Over the course of the first seven years the owner would pay $79,048 in interest and taxes, or $11,293 a year. In reality the “tax benefit of deducting mortgage interest and property taxes” is offset by the fact that even a non-itemizing couple would get the standard deduction of $12,750, so the “benefit” for owners is negligible in this case, but just to give Trulia a handicap, let’s incorrectly calculate the “benefit” as 25% of $11,293, or $2,823 a year. That shaves $235 a month off the monthly cost of ownership, bringing us back down to $1,431 a month.
Finally, they mentioned that they included opportunity cost in their calculations, so let’s assume that you’re able to find an investment for your $60,000 down payment that would return an average of 5% over the seven year timeframe. That’s a difference of 1.5% from the interest rate on the mortgage. Seven years of annually compounding interest gives you a gain of $6,591, or about $78 a month, bringing our total ownership cost to $1,509 a month.
$1,509 is quite clearly a lot higher than the $978 a month claim being made by Trulia. So what gives? The answer is above:
We factored in …the proceeds from selling the home after seven years with modest home price appreciation.
Ah-hah. So when Trulia says they’re comparing the monthly cost of renting vs. buying, that’s not really all they’re comparing. They’re making some major, unspecified assumptions about home appreciation in these calculations. Let’s work backward to try to figure out Trulia’s assumed appreciation rate.
In order to get $1,509 a month down to $978 a month, we need to profit a total of $44,604 on the home after seven years ($531 × 12 × 7). To obtain that much in-pocket profit, we would need to sell our $300,000 home for $373,676 in year seven. After we pay two real estate agents 3% each and the state government takes their 1.78% share in excise tax, that leaves us with the necessary $344,604.
An increase in home value from $300,000 at purchase to $373,676 seven years later comes out to a total increase of 24.6%, or 3.2% per year. Is it safe to assume that your home will appreciate 3.2% a year, every year for the next seven years? Maybe, maybe not.
Even worse, if you eliminate the bogus interest deduction “advantage” detailed above you would need to sell the home for $395,167, which comes out to 4.0% required annual appreciation. That’s a pretty unrealistically optimistic assumption, in my opinion.
The bottom line here, in my opinion, is that if you’re going to make claims like this:
Buying is cheaper than renting by several hundred dollars a month in every large metro.
You should be a lot more transparent about the major underlying assumptions regarding home appreciation. The word “appreciation” appears only once in Trulia’s entire post, with no specifics about how much they are assuming, and yet without the assumption of 3-4% annual appreciation the monthly cost of buying in the Seattle area is 54 to 78 percent higher than they claim it to be.
For the record, if you just look at actual monthly costs (i.e. drop the assumption of profit through appreciation), you would need to find a home that costs only $140,000 in order to keep your monthly costs down to $978.
This “report” seems disingenuous to me.