First-time homebuyers are MIA -- renting

Investment Analysis Clubs Macro Economic Trends and Risks
21

Not at all. Intercst isn’t assuming that his monthly rental payment is invested in the stock market, just the 20% down payment on an equivalent property. People have a hard time grasping the difference between 4% average appreciation on US residential real estate (with about half the of the homes appreciating at less than 4%) and a 10%+ annualized return from the S&P 500 over the past 30 years. You’ll literally be wealthy enough to rent a castle after 30 years if you think you need one.

I gave an example of the rent vs buy decision when I moved from New York to Houston in 1981 in my “Minimizing the skim” article from the Retire Early site.

{{ When I moved to Houston from New York in 1981, I rented a 600 SF unit in a large garden apartment complex less than a mile from the Galleria Shopping Center for $400/month. The owner was in the process of turning half the property into condos. A 600 SF condo was selling for about $45,000 at the time. Mortgage interest rates were around 14% in 1981, but with itemized deductions and a high enough salary, after tax, the monthly cost of owning was about the same as renting.

Today (2021) that 600 SF Houston Galleria area condo sells for about $100,000 and the 600 SF apartment rents for $850/month. If you put the 20%, $9,000 down payment on the condo in an S&P500 index fund over the past 40 years, you’d have $693,000 today and the 1.6% dividend yield (about $11,000/yr) would more than cover the $850/month apartment rent.

{Note: And lest you think I was living in some rat infested Houston tenement, one of my neighbors at the time was the mistress, Executive Secretary, and future wife of real estate developer Gerald Hines.This was a nice place to live in a convenient location with lots of amenities.}

I lived off and on in Houston for 25 years before I fled Texas for Washington State in 2006. It was a marvel to observe the low housing costs in the city. As REITs continued to build new apartment complexes as far as the eye could see, my monthly rent barely budged. When I left town, I was paying less than $600/month for a 900 SF unit in an apartment complex with several pools and tennis courts. I guess real estate developers are going to develop, and builders are going to build, as long as investors keep throwing money at them.

The biggest obstacle to real estate returns are the transaction costs. I can sell a $1 million block of stock for a 0% commission and perhaps a 2 cent bid/ask spread on a heavily traded stock like PFE (i.e, 20,000 shares @50/share x 2 cents/share = $400.) Where I live in WA State, it would likely cost at least 10% or $100,000 to sell a $1 million home if you’re paying a 6% commission, the 1.7% state franchise tax on real estate sales, plus the usual closing costs like title insurance, escrow fees, etc.

The rent vs. buy calculation didn’t turn positive for me until 2012 when rental rates started to rise after the 2008 Housing & Mortgage collapse forced lots of people out of their homes and into apartments. I didn’t buy a place until I found a property that was 70%-off it’s 2008 value and the equivalent monthly rent on the purchase price was 1.20%. (i.e., it was renting for more than the 1% benchmark that many investors use.) It was a phenomenal deal and quadrupled in value over the next 10 years. (I paid cash for the home, since I had enough money sitting in money market fund at 2% interest at the time to cover the purchase price and mortgage rates were about 3%.)

That’s the kind of unicorn you need to find in the residential real estate market to get anything like the unleveraged return on the S&P 500.

intercst

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22

Me, too. But I find a lot more security and stability in an ample bank balance and diversified stock portfolio. The only reason I’m willing to hold a risky asset like a home is because it’s a small portion of my net worth and I can afford to write it off when and if the shizzle hits the fan.

intercst

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23

Sure - but there’s also leverage and taxes.

If I have $100,000 and invest that in the S&P 500 and earn 10% a year for thirty years, I’ll end up with an ending balance of about $1.75 million. Of which $1.65M is taxable.

If I have $100,000 and use it to buy a $500,000 house, and the house appreciates by 4% per year for thirty years, I’ll end up with a house worth about $1.62 million. Of which about $1.12 million is taxable, and of which I can exclude another $500K from taxation.

Note the two values aren’t that far off even in absolute terms, and I probably have a more valuable asset in the home purchase scenario because of the tax advantages. That’s the power of leverage.

We’ve gone over ad nauseum all the other benefits/costs of home ownership - owning your own home makes it harder to move around but protects you from being forced to move, you have more ability to shape your home if you own it but more responsibility to fix things, etc. But in terms of the gross return on investment, the two options aren’t that far apart.

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24

Ditto this…except that I think the “shizzle” will entail significant stagflation so I think owning a house minimizes the risk whether a person is working (and possibly facing unemployment) or retired (and possibly facing rising rent on a fixed income).
Wendy

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25

Yep, you owned a Boston condo that became the DELL stock of real estate. Congratulations, but few people have that experience.

Doing a rent vs. buy analysis allowed me to avoid owning real estate in a area with poor returns (i.e., Houston) and eventually put a small portion of my stock portfolio ($12,500) into DELL which was worth 242 times my investment at it’s peak (of course, few people sell at the top, but I kept enough)

intercst

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26

I’m more worried about a Cascadia earthquake or climate catastrophe, I can handle the stagflation.

Everything I’ve read about a major earthquake in the Pacific Northwest describes a pretty unlivable situation for several years after the quake. I’ll be decamping to someplace else shortly thereafter.

intercst

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27

Hmmm…you have a point there. I handle the risk by the very scientific method of crossing my fingers. :wink:

Wendy

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28

Yep. And a married couple can currently take a bit over $120,000/yr from a portfolio in qualified dividends and capital gains in the 0% bracket, if that’s their only income for the year.

There are significant advantages to LTB&H investing in a taxable account.

On the use of leverage, it’s always preferable to avoid it if you can realize your financial goals without it.

When I was working for Exxon, I had colleagues who were bringing big checks to a real estate closing AS THE SELLER, because they lost their equity, were underwater on the mortgage balance, and still had to pay the real estate commission to close the sale and get out from under it. It happens.

intercst

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29

Yes, that happened in oil patch areas like Houston and Denver, where the boom and bust cycles predominate the local economy. That occasionally, but infrequently happens in other places where the economy is not so single-industry concentrated, nor vulnerable to the ups and downs of a volatile commodity. (But yes. It has happened. Florida swampland/condos, etc.)

Heck, I lived in Pittsburgh (twice) during the cratering of the steel industry (70’s & 80’s) and there was not a lot of that sort of thing going on because there were other supporting local jobs: university, medical, airline, etc.

Weird, because it keeps happening to me.
First house (condo) $65k —> 30 yrs —> $1.04M
Second home (Pgh) $189k —> 4 yrs —> $219k
Third home (Chi) $389k —> 5 yrs —> $425k
Fourth home (Knox) $287k —> 20 yrs —> $389k
Fifth home (Knox) $950k —> 5 yrs —> ~$2M*
(*not sold (yet), and we added around $300k of improvements before & since moving in)

It’s important to remember that the condo while “bought” at $65k, was really only $10k in, and the “mortgage” for the next 4 years was the equivalent of rent. So that’s almost a 13% compounded rate.

If I do the same over the other houses - not calculate against purchase price but against “what I paid in downpayment”, (ie: show the leverage) and ignoring my rental/mortgage costs thereafter because I would have one or the other anyway, I have

Second home: ($20k in) 25% annual rate
Third home: ($200k in) 4%
Fourth home: ($287k in) 1.5%
Fifth home: ($950k in) $9%

Obviously the more I put in, the worse my return. There’s a lesson there for you youngsters :wink:

As for ancillary costs, well yes I was lucky there. For the first three, Westinghouse picked up moving costs, closing costs, points (if necessary) and even offered a FMV price to buy the old house if I couldn’t private sell it within 6 months of the transfer.

Anyway, nothing. Is guaranteed, I’ll grant, but I think Intrcst’s experience with one of the worst real estate markets in the country (twice!) has severely colored his view. And no, most people aren’t going to pay a lower rent and put the money in the market. It would be nice if they did, but that’s not human nature, and frankly that argument is worthy of the Hocus award for wishful thinking. (Readers of the old REHP will recognize the award for the poster who insisted that no one could ever live by the 4% withdrawal rate, because: people. He was so adamant I think he had a breakdown over it. No, I don’t think JG is on that same path.)

So: real estate. It never goes down! OK, once in a while, but not usually.

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30

In securities investing, sure. But nearly all home purchases made by folks doing a “rent vs. buy” calculation are going to have a mortgage - so you have to consider leverage in figuring out what the ‘typical’ person would experience in terms of returns.

Look - everyone has a tendency to universalize their own particular experience, and generalize it to the world around them. In your personal life, you avoided buying into a home that would end up returning far far less than the typical residential real estate property (2% vs. 4% over 40 years), and you’re comparing it to a period where the market returned close to 12% rather than the more typical 10%. In your specific life history, renting rather than buying ended up being a fantastic, perhaps life-altering decision.

But you can’t generalize that to the typical person. Homes in the U.S. have generally appreciated a little more than 4% per year over the long term, not 2%. So for most people that have gotten into a property with 20% down (or less!), the typical leveraged returns they experienced would end up being comparable to the returns they could have gotten on their down payment in the market.

YMMV, past performance doesn’t predict future outcomes, etc. But I think it’s a far more of a wash for the typical person than your atypical experience has led you to conclude.

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31

So you pay
$500k principal
$???k interest
$???k insurance
$???k taxes
$???k maintenance
to get to $1.62m over 30 years

what is the IRR on that?

I see the value in owning a home, but mostly as a place to live (which is important), but not so much as an investment.

But, every property is unique and everyone here is above average.

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32

Buying is a great decision if the mortgage is a rent repalcement strategy. IE if you PITI is what you would be paying for rent anyways. At least with buying you get some equity (despite the vast majority of your monthly payments going to not equity or interest/insurance/tax). In theory, thats just a forced saving account that appreciates. Its reasonable to think you would at least get your money back and have gotten to live somewhere for free.

My BIL lived in his house for 7 years. Sold it for 250,000 over what he still owed the bank (i think he sold it for around 650ish). PITI was about 3000 a month. So he paid $250,000 to live there, or essentially lived for free for 7 years.

I think the one consideration that colored my decision to rent for so long was that i could rent a MUCH nicer place than i could buy for the same price. It would be a significant downgrade to own in the city at the same monthly payment. This completely flipped when i moved to the midwest. We looked a long time for a sfh rental could not find anything that wasnt outdated or unkempt, even for a premium. So it just made sense to buy, just to have something liveable, even at the 7% interest rate and high taxes for the school district.

So somehow moving to the midwest we doubled our housing costs. Loll

I guess rents are so low and housing so expensive that financially noone wants to be a sfh landowner to rent it out here

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33

No. My personal experience is irrelevant to the arithmetic.

I’m making the point that by doing a simple rent vs. buy analysis to inform your real estate choices, you can avoid situations where real estate is likely to underperform (i.e., the 25 years I lived in Houston on and off) and capitalize on it when the market delivers that rare opportunity to buy a property with a good prospect of an S&P 500 like return (e.g., buying a home in a Portland OR suburb in 2012 at 70%-off its 2008 value.)

Today when you can rent a $500,000 town home for $3,000 to $3,500/month in my neighborhood, the calculation clearly favors renting. I’d be selling myself and renting if my condo was a meaningful percentage of my net worth. {{ LOL }}

And note, I agree with you that this strategy only works if the money you’re saving by renting is being invested in the stock market and concede that many people will spend the savings rather than invest. But the path is there for those willing to do a little arithmetic to inform their choices.

intercst

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34

Don’t know, but that’s beyond the discussion at hand. This isn’t intended to be a complete discussion of the relative IRR of rent vs. buy, but just whether you do better on the capital appreciation part of the analysis. Because it’s absolutely true that the homeowner has to pay all those things - but on the other hand, the renter who puts the down payment in the market then has to pay rent.

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35

IRR is a measure of return on investment

how else would you measure capital appreciation?

36

Also has to pay those things, they’re just hidden in the rent. Exceptions apply.

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37

Yeah, if you know when real estate is going to underperform or not. You can increase your stock returns if you time the market and get out when the market’s going to underperform, and get in when the market’s going to outperform - but few ordinary people have the skill to do that (or pick individual stocks successfully, for that matter). The average person isn’t going to be able to know or figure out in advance whether they would do better using their capital as a down payment on a house or in the market.

Over the long term, historically residential home prices have appreciated about 4.3% per year (from the mid-1960’s). The S&P500 has returned about 10.4% per year over the same time period. But because home purchases are typically leveraged, the typical home purchaser’s actual return over a 30-year time frame on a 20% down payment would be about 10.1% - pretty close to the historic return on the market.

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Renter Buys Condo in same NY Highrise
38

We have advanced just about every nuance that I can think of on this topic at least since I arrived at tmf in 1998. Over the years I have come to think of my home as an expense to be managed largely because raising my daughters in a rental was not the best option for us when we started our family 46 years ago.

That being said, I could also characterize it as an alternate investment to the extent that all of our homes since 1981 have accreted in value while we lived in them. On the one hand, our present home, purchased in retirement 6 years ago, has increased in value by about 50%, whereas our equities have increased by nearly 100%. But if I sold my house now, the gain, up to $500,000, would be exempt from taxes whereas my stocks would be taxed at varying rates.

Since I do think of our home as an expense to be managed, we buy modest homes that fill our needs but are a small percentage of our total net worth. When we bought our present home it was about 10% of our net worth. Now it is closer to 15% of our net worth.

Having a comfortable home that is a small percentage of our net worth is like a security blanket. A place to live even in the face of a 1929 stock crash or 1970’s stagflation scenario.

Not sure I added anything to the conversation.

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39

We’re just simplifying it. If you buy a home, your costs are more than just the down payment - you have to pay all those other things. But you get the use of the house. If you rent instead of buying, you get to put your down payment into the market instead of putting it in the house - but then you have to pay rent somewhere.

So intercst and I were just talking about what happens to the asset that gets invested (the down payment going into the house vs. the market), and setting aside any discussion of those other costs. If one type of investment absolutely crushed the other, then you don’t need to get very granular in looking at the other annual costs when making the comparison. But you generally get the same return on the down payment money whether you put it in the house or the market, so whether to rent or buy isn’t a no-brainer - it very much depends on all the specific costs and benefits of both.

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40

I’ve owned, and rented, in Michigan. So except for current house, not steaming hot real estate markets. Current house is really the 1st one that is certain to be large gain. On others, when including insurance, taxes, and upkeep, slightly over break even.

Just got done staining the deck. Took my time, probably worked no more than 5 hours each day, for 5 days. Never did that way back when I rented. Have done a bunch of remodel work, never did that when renting. Not to mention the lawn work now, huge task of handling the leaves that drop in the Fall, snowblowing in the winter, etc.

I luv having the privacy and “freedom” to indulge in loud music, woodworking and power tools, etc, but I totally get how renting can be just as good. Money isn’t everything, but time is pretty darn important, and maintaining a property is work, no doubt about it.

In this current location, am thankful that I own, it is too expensive to buy, and too expensive to rent. I feel for the younger working-class folks with a family, trying to get at building their lives. The working-class wages do not equate to the costs of buying, within a 20 mile or so radius.

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