This statement isn’t sufficient, as you well know. That’s because when you buy a $300,000 house, you are initially investing $60,000 (20% down) plus fees, etc. The rest is amortized over the next 30 years. I just made a quick and dirty spreadsheet, with very rough estimates of rent over 30 years, and investing the $60k into the S&P up front, and investing the difference between mortgage+expenses-rent each year (starts out positive, but becomes negative eventually because rent goes up and with a fixed 30 year mortgage, PITI doesn’t go up as fast) and the difference isn’t as stark as 4% versus 10% when you account for each of the 30 years of cashflows and look at the bottom line at the end of 30 years. In fact, oddly enough in my really rough spreadsheet the numbers (total worth at end of 30 years) end up pretty close to each other. I used 3% for rent increase, 3% for home value increase, and 10% for S&P500 return.
Oh, I’m definitely not saying to do this for an individual home. That would be essentially meaningless. It has to be done across a wide swath of homes, first perhaps across all of them in the country, and then later, maybe to see if there are large variations, across regions. Again, just like SWR calculation, it’s an effort to see how assumptions today would have fared using all the previous periods. It’s no guarantee that if starting today the period is “the worst” ever that the average person won’t be worse off, because obviously they will be worse off (just like if we happen to have a sequence of 30-years worse than began 1929 or 1966).
{{ For example, when I bought my current home in 2012 for 70%-off 2008 value, monthly rents in the area were 1.2% of my purchase price (i.e., 20% higher than the benchmark “fair monthly rent is 1% of the property’s market value.” A clear signal that buying was better than renting.}}
That’s what I mean when I say it’s a “point in time calculation”.
Since buying is generally a long-term commitment, you need to look at the long-term impacts when doing a comparison. This analysis did not.
Sure, you can re-look every year. But that doesn’t necessarily give you the best long-term outcome, especially when, like this analysis, you are only looking at current costs, not long-term impacts. It’s like people who boast about paying $0 in income taxes for 3 - 5 years after they retire, without looking at the impacts that RMDs will create, including boosting them into a higher marginal bracket than when they were working, plus having to pay IRMAA for their Medicare.
Houston for the 25 years I lived there off and on was 1% per annum home value increase and slightly more than 1% on rent. (Of course, there was a 50%+ dip in rents during the oil price crash in the mid-1980’s when everyone left town and I decamped to a beach in California.)
Given that you were there during the oil bust, that’s not surprising. That said, the house that I bought in Houston in 2004 for $220k is now estimated to be worth $425k (Zillow) to $450k (Redfin & Realtor.com) Over 20 years, that’s a 3.34% - 3.64% CAGR
Forgoing the $100,000 “free Obamacare” windfall wouldn’t have eliminated IRMAA for me, or reduced my lifetime tax burden by anywhere near $100,000. Like I’ve said, you do what has the best present value, at the moment, with the tools and tax loopholes available to you.
On rent vs. buy, unless you’ve identified a property, and moment in time, where real estate appreciation exceeds the S&P 500, you’re going to be better off putting your 20% down payment in the S&P 500 and renting. That was true in Houston, when I lived in California, and the first 6 years I lived in the Portland OR area. The only thing that turned the tables was the housing market crash in 2008 that collapsed property values, and the rise in rents 3 or 4 years later as people defaulted on their mortgages and moved to rental units. It appears to be an unusual confluence of events, historically.
Yeah, but that’s not what the article on rent vs. buy that you linked to is doing. It’s only looking at current rental costs vs. current ‘cost of ownership’, including total mortgage payment, property taxes, insurance, maintenance and repairs, not any NPVs, depreciation or appreciation:
{{ They also looked at CoStar rent data and made assumptions based on average insurance costs, home prices, and mortgage rates, as well as the cost of home maintenance, property taxes, and closing costs to calculate a true cost of ownership. }}
That’s why that’s an excellent study, and why the cost of owning a home was less then renting in only about 24 months (2011 to 2013) out of the 23 year period they examined.
Home maintenance cost varies widely. It might be 1% per year in a dry temperate climate like Salt Lake City, and 3% plus per year in coastal Florida. If you’re buying an existing home, it’s likely coming with several years of deferred maintenance, since most people don’t look at stuff until it’s inoperable, leaking, or broken. It’s only recently that insurance companies have started flying drones over neighborhoods to see which of their customers have been naughty or nice with respect to upkeep. And then you have to add a reserve for holding an illiquid asset that will cost you about a year’s worth of rental income to sell versus holding a one-year rental agreement with perhaps liquidated damages of one month’s rent and loss of security deposit if you need to move, and a steadily growing S&P 500 index fund with your 20% down payment.
After writing that, I’m even nervous sitting in my mortgage-free home in a state with low property taxes. {{ LOL }}
This is only your starting point, much like buying a stock to buy and hold at a reasonable price. Unless you are looking to flip a property, you have to look at long term impacts of owning, including appreciation. This is why I do a spreadsheet to look at 10 year impacts of investing in a property, even if the intent is as my residence. The original spreadsheet that I downloaded has been “improved,” and no longer what I use exactly, but here it is: 10-Year Investment in Real Estate Calculator The version I downloaded wasn’t locked and I could change the format to suit my needs, depending on the intended use for the property.
Appreciation is based on the whole purchase price of the home, not just the initial investment, and impacts the calculation in a huge way. You may have put in $25K (20% plus closing and initial repairs,) on a $100K property but the appreciation is based on the $100K. You have to be careful with it. Care must be taken to make sure you have enough cash flow to get to the end point, (annual maintenance costs are part of the spreadsheet.) I always ran the property in two ways on the spreadsheet, to pacify my non-real estate loving DH, who insisted on seeing a zero appreciation scenario along with a more conventional scenario for appreciation based on local historical data, (even though he did not expect the same caution when it came to share price of stock.) Grumbling aside, given other than through choice in location one has little influence on what their market does, he wasn’t wrong. At least he was OK with simply a break even with no appreciation.
Appreciation is a huge impact over time, and since the general consensus in buying real estate is that you should hold it for at least 5 years, it’s rather pointless to analyze your return for less than that. It is crazy how much appreciation adds to the bottom line with time. Crazy good, if you are careful in your location and can choose your exit point, as pricing is not necessarily a straight line. The house we sold last is a perfect example of that. Was a great investment for us, but the previous owners, who bought at the height of the real estate craze for our area, sold to us at almost the price they paid for it, updating kitchen and baths for us, both big ticket items. 5 years later we sold for 60% more than we paid for it, having put in very limited improvements.
So same location, but we waited for our exit point. Even when touring the home as a candidate for purchase, I commented that if it turned out we were not a fan of the city, and no longer wanted to live there, it would make a great rental. Sure enough, after two years there we bought another place 7 miles away and put the property on the rental market…something I had already analyzed the benefit of prior to buying. Rented it for just under 3 years and sold with tenants in place with full capital gains exclusion because it was our primary residence initially. In addition, the tenants paid our mortgage for those 3 years, as well as a paycheck to me on top of that for the work I put in.
Just like buying stock in a company, you want to look for a moat around your real estate purchase. What makes this property superior against the competition? I look for barriers to new entry. Is it easy to build new, or are there geographic and zoning blocks in place? I never want a place that competes only on price and look for features that people will fight to get. I never buy a place I am not willing to live in personally, and my standards are upper middle class, which is the demographic I rent to, and no doubt one of the reasons why our biggest deterrent to getting and holding a tenant is their desire to buy. I want breadth in economic stability with multiple industries, so the incomes are not just dependent on industries like the oil refining area we lost money on in real estate, when we had to sell during one of the down cycles in refining. With low correlation employers from universities, hospitals, tourism and the defense industry, all in one place, downward cycles tend to be shallower and shorter than that experienced by the most of the rest of the country.
I love buying these places, if they also come with a killer lot, good bones and good flow. A talent for recognizing untapped potential, and being a skilled negotiator who is willing to move on if price is not met, are critical skills that most of the public does not have when it comes to buying real estate. It can be learned, however.
I never said real estate was a thoughtless investment, but it can be lucrative with risks that can be minimized.
You are a renter through and through then. That’s OK…real estate investors need your type too. I love 30 year fixed mortgages as an inflation hedge. It’s really nice getting 5% on my cash while paying 2% on a mortgage I could pay off.
You know that one could obliquely read this statement as “buying homes is great when there are very low interest rates to be had, but not so great when interest rates are normal or high”. That’s very close to what @intercst is saying … when buying becomes so much cheaper than renting, it’s time to buy, but when renting is cheaper than buying, it’s time to rent.
The thing about a mortgage being an inflation hedge is doubly true when it has an absurdly low interest rate (compared to prevailing rates) on it. That’s because you get the inflation hedge from the delta between current interest rates and the low mortgage rate AND you get the inflation hedge of the property that is mortgaged.
I don’t find these types of CAGR calculations to be particularly useful. The only CAGR that really is meaningful is the one calculated across ALL the cash flows through the entire holding period. Doing the CAGR like this is akin to saying the S&P500 was 1000 20 years ago, and is 4700 today, so the CAGR is 8% by simply ignoring all the intervening cash flows and only using the first one 20 years ago, and the last one now. The actual CAGR of the S&P500 over that time period is closer to 10% if you include all the cash flows. The same holds true for real estate. And because real estate almost always uses leverage, and has all sorts of intervening cash flows, a meaningful CAGR calculation is much more complex.
And one would misread what I am stating. I refied down to a 2%. It can be a strategy to buy when rates are high, if prices are lower at that time, which has happened in the past but is not happening now due to low inventory. The calculation for affordability and profitability was done at a higher rate, and I even ran a scenario of paying cash, (and made a cash offer, which won us the bid,) but I LOVE the option to make it even more affordable by refinancing, and earn even more than expected by having your cash that would have paid the full cost of the house sitting in a money market making more than your loan servicing costs while being available for further investments that come up. We never buy property with short term intent, though plans sometimes change. And because plans change, with one of my fall back positions being a rental, I want financing in place for tax deductions against income. It is wonderful when a tenant is paying your mortgage and you use your cash for further investment, even better when that mortgage rate is one issued for a primary residence, rather than at the higher rate and calculations used for a rental. That said, while that 2% mortgage would make for killer rental returns, the residence that is hitting the market in a couple of weeks has too much capital appreciation to ignore the tax consequences of capital gains exclusion that would be lost if we rented the property for more than 3 years, so we are selling and taking the roughly $450K in tax free gains we earned in less than 5 years, in addition to 5 years of living in a great place.
For someone so gung ho on keeping his funds in the stock market while paying rent, I have no idea why Intercst paid for his home in full rather than get a mortgage. No seller actually cares how the house is paid for, but you do have to show proof of assets with a cash offer, which may need to be used to complete the purchase if problems with financing evolve. There is no mortgage contingency on a cash offer, obviously.
I remember the 18% FRM rates in the 1980’s, held a 5 year balloon at 9% in the 1990’s. Todays rates are not the cheapest, but they are cheap. May not be so down the road, but if rates are significantly different than when you buy, then you refi if they go down, or if they go up enjoy the short term returns on cash you didn’t use to pay for the house.
That said, many people seem to buy at or above their means, and will buy as much house as they can afford at the time. To me that is a recipe for disaster, but I tend to lean in the direction of buying what I need, without deprivation, but typically less than I can afford. I have learned the lessons regarding having a house own you, rather than you owning the house. It’s not a comfortable place to be when life throws a curve ball.
Exactly. In the '80’s, with mortgage rates at 18%, Dad had a 5% FRM. He was contacted by the bank holding the mortgage and asked if he would like to pay it off. He asked them how much of the principal they would forgive for his doing so, and declined their offer when they told him no forgiveness. He was earning something like 12% on his money at that time.
IP,
a good listener, rather than someone re-inventing the wheel
Then I’m not sure why you didn’t object to @intercst’s claim that real estate appreciation (i.e. CAGR) was only 1% in Houston during the time that he lived there.
Exactly, which is why the article that @intercst linked to doesn’t show a true ‘rent vs buy’ calculation. While it claims to compare a ‘true cost of ownership’ by adding all of the expenses in, it’s not looking at the long term costs of renting, accounting for the appreciation enhancement you get by using leverage, nor subtracting out the principal pay down from the ‘true cost of ownership’.
Yep. For years, even decades, now I’ve always said “you can always refinance the loan, but you can never refinance the purchase price”, in other words, better to buy at low prices with high interest rates than at high prices with low interest rates. And as you mention, this time we are seeing high prices and high interest rates (they’re not really high, just higher than we are used to).
Probably because the price was so low that it wasn’t worth bothering. If you spend 2-3% of your net worth on your house, then perhaps it doesn’t make much of a difference anyway.
Reminds me of a friend who went to college in the late 70s/early 80s. He didn’t require loans to pay for college, but he was eligible for loans each year. So he took out something like a $5k loan each year and put it directly into a multi-year CD at double digit rates. Interest wasn’t charged until 6 months after graduation, so he paid off all those loans and kept all the interest. It was a great deal for him. I needed the loans to pay for school, so I paid them off over the 9 years after I graduated.
It’s an asset allocation decision. As long as I’m buying a home at a price that provides a good prospect of getting an unleveraged S&P 500 return in price appreciation, it provides some diversification. I just wouldn’t accept a sub-S & P 500 return to diversify into real estate. Plus I’m getting about a 75% discount to the market rent, since I’m only paying property taxes (in a low tax state) and a HOA fee (no mortgage). For the past 30 years I’ve approached real estate as an expense to be minimized rather than an investment. This was a way to make my housing costs cheaper.
Could I have taken out a mortgage, and invested the purchase price in stocks? Sure, but my asset allocation was already 95% stock, 5% cash and fixed income. Did I really need a higher asset allocation to stock? As Mark notes, the purchase price was only 2% to 3% of my net worth at the time. I had sufficient funds sitting in a money market fund earning 2% interest to cover the purchase. Why increase my costs by paying 3% on a mortgage? My unspent dividend income over the next 2 or 3 years would replenish my 5% allocation to cash and fixed income.
Of course, the only reason I have this kind of flexibility is because the money most people have tied up in a home, I had invested in the stock market and compounding apace over 30+ years.
That’s the return for the Houston condo I mentioned in my “Minimizing the skim” article. A purchase price of $45,000 in 1981 grew to $100,000 in 2021 when I wrote the article. I just looked at Zillow, current asking price for a unit there was $146/sf. It’s dropped to $88,000 since for a 600 SF condo – a sub 1% return over 43 years. {{ LOL }}.
I noticed that they’ve even built a Dog Park across the street in the 40 years since I lived there. The neighborhood is improving.
Well, if you were looking at a 600 sq ft condo, then I’m not sure why you wouldn’t be living in an apartment instead. Even the apartments that I lived in were all larger than that, and the smallest house was 1200 sq ft And having lived in Houston, that particular neighborhood is not a place I would choose to live. The fact that the asking prices are only $146/sq ft backs that up. The current estimate on my old house is around $215/sq ft.
I will also say - in general, condos have lower appreciation rates than SFHs - precisely because they are much more like living in an apartment.
When I lived there in the 1980’s, Real Estate Developer Gerald Hines’ Secretary/Mistress lived there. How bad could the neighborhood be? (She eventually married him and now has his fortune.)
Yes, there is a cost to leverage, just as there is a cost to paying cash, which you seem to ignore. Since you choose not to use leverage, you need to include the amount of money the purchase funds would have earned, and all upkeep costs as part of that rent. You may not be getting the discount on rent you think you are getting.
It’s pretty obvious that you are hyper focused on cheaper is best, which could be why you have not had good fortune in real estate. With some exceptions, like the riverfront property we bought out of pre-foreclosure, cheap real estate is cheap for irredeemable reasons. Any property, no matter the condition, will sell if you lower the price enough. While there is still a resale market for these properties, they will always sell because they are cheap and people can’t afford more. That limits your resale value in an industry where good sales are dependent on the number of qualified eyeballs you can get on your listing, and triggering positive emotions in those qualified buyers. Your approach to real estate is kind of like buying a stock because it’s $5/share, instead of one that is $50/share, and failing to look at the books of the companies to see if the higher share price company is a better investment.
I am in real estate to make a profit, as well as have a great place to live while there, looking at profits down the road rather than simply minimizing current expenditures. I am less concerned about initial price than untapped potential and lack of fatal flaws, as opposed to your bottom feeding approach. Think of it as buying a growth stock prior to the industry taking off. Few buyers can see past poor decor to potential, with most not being able to see past one room in the house being a color they can’t stand, or better yet…wallpaper!
Yes, this has worked for you, someone who also declared marriage and kids were too expensive. Your net worth seems to be your baby and I understand your need to defend it, while believing there is more than one way to approach life and a healthy balance sheet. I am not here to convince you, but to let others know that there is more than one way to get to a solid net worth. I started saving for retirement at 19, bought my first house at 21, retained it as a rental when I bought another 2 years later. Left my career and became a SAHM when our first kid was born. Was able to retire at 50, waited for 55 when eligible for retiree health care, (postponed to 58 by DH who didn’t want to quit and still consults on projects from his previous employer, who 7 years later has never stopped trying to get him to come back.) This was possible even after paying, loan free, about $500K for two college educations, on top of the high cost of raising two kids. I do tend to share your cheapest is best approach when it comes to non-appreciating assets, like cars, though again making sure to balance price against our wants and needs in the process. I suspect our net worth is less than yours, but it is such that we are gifting our kids the max amount annually, (part to fund their Roth, while they max out their 401K, and the rest to accumulate towards an investable moment, be it a house or a grad degree,) in the belief that they can make better use of it than we can, and since we have more than we need, this puts the funds to better use with lower tax consequences. I measure my life in more ways than the size of my bank account, while making sure to never be a burden on our kids, as well as give them every opportunity to advance.
There is more than one way to get to a healthy net worth, but since this is a rent v buy thread, with some exceptions to timing, I reject your idea that it is better to rent than own, unless of course part of that approach is buying what is cheapest and ignoring what is the best value because of a higher initial price.
