Home ownership vs. renting

Investment Analysis Clubs Macro Economic Trends and Risks
21

A large landlord has economies of scale and is buying maintenance services at wholesale prices, an individual homeowner is bringing in a plumber to fix a leak at retail.

At least in Houston, I noticed that the owners of the 300 unit apartment complex I lived in were paying much lower property taxes per square foot, than the condo owners next door. Also large apartment complexes seem to be sold as tax dodges for the wealthy (i.e., they can use the depreciation to shelter other income.) If they can make money running the rental operation that’s great, but it may not be the primary reason they own the building. Places seemed to get sold about once every 10 years, and the depreciation cycle gets started anew. If you’re not in the top tax bracket, the real estate income tax deduction may not be worth much to you.

On insurance, it’s pretty common for victims of hurricanes and floods to get less than 100% recovery on their claims, even if you have “full coverage”. That’s why I favor a small real estate footprint that I can comfortably “write-off” in a disaster – or let my landlord worry about it.

Again, if you look at the chart I linked to, there’s often a large gap between the cost of buying vs. renting which has matched my own calculations over the years. The real estate and mortgage broker industry would prefer that people not know this, just like your stock broker would prefer that you not understand low-cost index funds.

If a renter is capturing the rent vs, buy difference from age 25, rather than waiting another 30 years to age 55 to pay off the mortgage, that’s an insane amount of compounded investment returns. I paid cash for my home in 2012 at the age of 56 since I happened to have enough money sitting in a money market fund to cover the purchase price, and my unspent dividend income over the next 2 or 3 years was enough to replenish the money market fund with my “5 years’ worth of spending in fixed income”.

1779×1042 27.5 KB

intercst

3 Likes
22

That’s the difference between the average 4% appreciation in the housing market (and about half the homes in the US appreciate at less than the 4% average) and 10% plus for the S&P 500.

Here’s the example I outlined in my “Minimizing the Skim” article from 2021

"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.

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.

And note, I found the upscale neighborhood in West Houston where I resided to be quite pleasant and comfortable. Houston was a great place to live. It just wasn’t a particularly good place to own a home. You were much better off keeping your down payment in the stock market.

intercst

5 Likes
23

You’re making a different (valid) point, that over a longer period, STOCK equity has grown faster than REAL ESTATE equity. For many who didn’t have the discipline to set aside money to invest in stocks, “investing” in real estate when they had to live somewhere regardless was the closest opportunity they had to “invest”. My main point here was that homeowners who buy a house then re-do it every ten years are essentially destroying equity by throwing out components that should have lasted 30+ years, getting nothing for them, then buying replacements at current prices. In effect, they are paying a 30 year mortgage on accoutrements that were treated like throwaways. In effect, these homeowners aren’t even getting a 4% return on the portion of the original purchase price getting tossed to the curb during each remodel. They’re getting zero.

WTH

4 Likes
24

Exactly! Almost all the “upgrades” that homeowners do to their home don’t result in enough of an increase in market value to make it a good investment. It’s largely wasted money. Cheaper to rent a place with the amenities (pool, tennis court, sauna, etc.) you want.

intercst

25

It can’t be directly compared, because stock is [usually] bought 100% equity, while real estate is usually bought 20% equity and 80% debt. That makes the comparison more complicated.

Let’s say you have $50k and have to choose between renting or buying. You either buy a $250k house with $50k down, or you invest $50k into an S&P500 fund. $200k at 6% costs $12k interest slowly declining with amortization. So the total cash flows each year vary, the S&P500 fund with 50k invested will return, say 10% a year, so it’ll gain $5k in first year and compound thereafter. And the house will rise by 4% a year minus the cost of the mortgage, so $250k rises by 4%, or $10k, subtract the $12k interest, and you are negative $2k. Now, if interest rates are lower, like 3%, then it is much more favorable, because the interest expense is only $6k, and the home value increase is $10k for a net positive $4k. Subtract rent, subtract homeowner costs, etc to get the real numbers.

4 Likes
26

First, where did the data for the monthly ownership amount come from on the graph? Seems like some wild swings, especially at the end.

Yes, you’re capturing the rent vs buy difference for a longer period, but I’m saving a larger number, the whole mortgage payment (yes, for a shorter time). Plus I have equity in the house.

I’m not convinced the difference is as large as the graph represents.

27

It’s not. By coincidence this weekend’s Barron’s has an article on this very topic. Here are a couple of salient parts:

Johnson’s ratios are just a snapshot based on current prices. Columbia real estate professor Christopher Mayer says that for people who plan to hold on to their homes for several years, buying a home still makes sense. It comes with a slew of tax advantages.

The biggest benefit from homeownership is usually not price appreciation but what economists call imputed rent—the money you would have to pay to rent similar lodgings. It is as if your house gives you a monthly rent coupon and there is no tax on it. If you rent that same house, you must pay your rent in after-tax dollars. And when you sell your house, a big slug of any price gains—up to $500,000 for couples or $250,000 for singles—isn’t subject to capital-gain taxes.

The quotes here are from a reverse mortgage broker, who actually advises elder couples to sell their appreciated houses and then rent. Here’s the money quote:

The couple who hung on to their home will have spent about $560,000 more during their lifetime than the renters. However, because they still own a house, they will leave $1 million more to their heirs, Kotlikoff calculates. Homeownership is, in effect, a form of forced savings with certain tax advantages.

To be fair, there is a good discussion of both advantages and disadvantages of rent vs buying, but on the whole, “buying” seems to win. (I am skeptical of intercsts posts, which all seem to revolve around “live in a box and you can save money”.

I can’t find any “gift link” option for Barron’s, so this link will have to do.

https://www.barrons.com/articles/rent-buy-own-home-retirement-4f316c90?mod=hp_RETIREMENT

It’s also true that the “you have to match the S&P” is a totally false meme. You usually buy a house with at least 80% leverage. You only have to do 20% as well as the S&P to come out ahead, yet you have a backstop asset which you do not have if you try to leverage yourself with a stock investment.

Yes, as time goes on your rent (out of pocket, after tax dollars) goes up, while with ownership your mortgage (tax deductible cost, lower than apparent cost, remains fixed.)

Well, no. ‘It’s true the market sets the rents, but then the market also sets the costs for buying the building. If the market rents are low, rental buildings don’t get built and demand outstrips supply. If you are very lucky you may find a landlord willing to lose money on you for a time, but then I suggest you will also live in a crappy rental. Yes, there are market distortions from time to time but they are not usually long lasting, nor often desirable.

Generational wealth. The majority of it, for the middle class at least, comes from real estate.

6 Likes
28

Right, and if you need to sell in a down market, the leverage magnifies your losses. Thus my preference to avoid the risk of a mortgage and all the extra costs incurred from acquiring a mortgage.

Two years ago Kotlikoff was telling folks to “try to buy in cash”.

intercst

29

19. Retiring early is financial suicide. Yes, there are situations where retiring early makes sense. But very few of us think of early retirement as what it really is: a decision to take the longest and most expensive vacation (that most of us can’t afford).

I wouldn’t take advice from somebody who says that. Or anybody who has 21 rules to follow for anything.

3 Likes
30

Zillow tells me that the monthly rental price of my home is about 80% of the monthly cost of buying it with a mortgage and paying the property taxes and HOA fee.

If I put that 20% difference in the S&P 500 over the last 30 years, a married couple can withdraw $123,000 per year in capital gains and qualified dividends in the 0% tax bracket, that’s enough to rent a decent home. What a lot of these rent vs. buy studies ignore is where you can Invest the savings and how you might be able to withdraw it with little or no taxes. Berkshire Hathaway is a God send. As Warren Buffett notes, “We are not taxable investors”.

So yea, I’m willing to buy a home if I can buy it at a price that provides me with some prospect of getting an unleveraged return of the S&P 500. But I have no interest in taking on the risk of leverage if it’s not necessary to meet my financial goals.

intercst

1 Like
31

See link:

The wild swings at the end reflect the toxic effects of high real estate prices combined with high mortgage rates. Homeowners my well decide to rent at a discount and hold on to the home rather than lose their 3% mortgage by selling and buying a home elsewhere.

Basically, I’ve been capturing the rent vs. buy difference you see in the years prior to 2012 and investing it the stock market at a much higher rate of return. That was 3 decades of compounded investment returns (1981-2012) that an owner of one the 50% of US homes with sub 4% price appreciation weren’t getting.

1779×1042 27.5 KB

intercst

1 Like
32

It was the first lesson our gay elders gave to us young whippersnapper would be Los Angeles Real Estate flippers (yes, it had elements of a fraternity):

Only pay for stuff that adds sales value, but if you want to live there for awhile, then calculate your frivolous potential “improvements” on a per/month that you will still be there basis.

Both renting and home ownership have pitfalls and widely varying cost benefits depending on when and where. Los Angeles in the 70’s - 90’s was a paradise for savvy home flippers. Now it aint.

d fb

2 Likes
33

We do know that bubbles develop in residential real estate from time to time. Some do get caught with properties under water. Ie loans larger than the value of the property.

But usually over time prices recover and you can sell at a profit. Often a large one.

I think many more buyers make money on their real estate than lose. (The no doc loan era being a major exception.)

2 Likes
34

On average, home real estate makes money long-term after inflation, but not much.

Housing (price only)
            Real rate
            of return
Since 1900     0.5%
Last 75 yrs    1.0
Last 50 yrs    1.1
Last 25 yrs    1.9

DB2

1 Like
35

Again, that’s an incomplete way to do the calculation. It is incorrect to look at just the price appreciation because you get a place to live along with the house.

And home real estate is usually leveraged. Most borrowers put about 5-10% which changes the ROI by a lot.

The imputed value of rent along with the leveraged forced savings plan is why home equity is a significant portion of household wealth in America. That’s why there is the trope of “you are throwing your money away in rent.” That is an oversimplification and not always true, but in a large swath of cases it is true, which is why the trope exists.

I want to be clear: it is not always better to buy than rent. In plenty of cases it makes more sense to rent. But you guys are looking at strictly the price appreciation and that’s the wrong way to do the analysis.

7 Likes
36

People need to start somewhere working their way into home ownership. Lower rental costs are coming our way. Higher pay is coming. The mix will anchor home ownership for more people over time.

1 Like
37

And we hope interest rates have peaked making ownership.more attractive.

38

Here’s why I strongly prefer owning to renting

  • I take care of the home and appliances so I have lower than most renters/owners in repair expenses
    (compare how people take care of rental cars vs their own…you pay upfront for the average rental destruction)
  • I do most of my own repairs myself, thus have lower repair/replace costs than most
  • I’ve done significant energy efficiency upgrades to my home that I wouldn’t/couldn’t do in a rental that lower my bills
  • I’ve installed solar PV. Paid for after about 7 years, so I now have essentially free electricity for many years
  • I’ve done numerous low-cost backyard improvements & landscaping, not do-able in a rental

All said, my current home has appreciated by ~8x in ~25 years, and my investments have also done well so I have no complaints.

Mike

7 Likes
39

I agree strongly on your entire set of smart engaged owner’s advantage over renters. I have done every item on your list over my owned homes with massive profits. A new fully home powering set of solar panels with big battery go in this fall (licking lips over Chinese hyperproduction of panels).

If you buy your home as an expenditure that gives you pleasure you probably lose out compared to renting. If you buy it as an investment opportunity that you have a lot of control over that incidentally gives you a “free” place to live? You often can have a bonanza.

d fb

1 Like
40

Yes, of course. BUT it is important to note that this can only apply to people who know they can stay put for a good number of years. If you are in a field where you need to change jobs periodically, and need to move to attain advancement, you will enjoy very few of the benefits of homeownership, and you will suffer ALL the large expenses … repeatedly. Take a typical person that has to move every 4 to 7 years for work, they will pay closing costs repeatedly, and they will eat much of the money they spend on improvements (the best ones return 80%, the worst ones return zero or negative).

So far, I’ve purchased one home in 1997 and still live in it. And even so, there are tons of costs, expected and unexpected that pop up every few years. Just this afternoon I needed a roof repair for $1600. I hope they fixed the leak!

1 Like