Here's part of Bill's email:
"Maybe this is common knowledge but I've been trying to figure it out. I see many happy renters, talking about the benefits of renting vs. owning at the moment. I feel similarly and I'm keeping my eyes open for the market shift which is likely more than a year out. Still, that last post about the place on [632 NE] Russell got me thinking."
Before I dive into my favorite part, the financial analysis, I want to start off by highlighting a number of misconceptions about buying and renting.
1. Renting is throwing your money away.
There are only three things you really need, right? Food, clothing and shelter. A house is fundamentally just shelter at the end of the day, but we've made it out to be much more than that. You can rent and let someone else deal with maintenance, taxes, etc. Or you can buy and manage all these things yourself.
Renting is not throwing money away, it's paying someone else for the benefit of shelter.
2. Owning is always financially superior to renting.
This assumes that real estate values are continuing to increase. This is certainly not true when the market is flat or declining, due to the increased expenses of owning. And is also not true for short periods of time due to high transaction costs. We'll cover this in extended detail in the next post.
Also, Robert Shiller has shown that real estate has basically kept pace with inflation over the long term, so while real estate on average has been a good (or bad) investment over short periods of time, over the long term you'll likely just keep up with inflation.
3. Everybody should own their own house
Frankly some people just don't have the financial maturity, common sense or ability to maintain a house. It's been said before, but most of the people that are currently facing foreclosure in areas like California would have been better off continuing to rent. Then there are the people who treated their houses like ATM's and have in effect already sold the house, and blown the money on "improvements" (granite countertops!) or vacations.
4. You'll save money on your taxes by having a mortgage.
This is what my wife likes to refer to as Spaving (Spending to save). Every online calculator I've ever seen over-estimates your tax benefit, mostly by ignoring the standard deduction that everybody already receives. Never mind that you're paying a bank $3 to save $1 on average, I hear this argument all the time.
5. You can't make a rental "your own".
Sure you can. Most people don't, but you can paint, plant a garden, pretty much everything short of major construction. In Germany we had to buy and install our own kitchen (and remove it later), which really allows for customization.
6. A rental will never feel like home.
This is one of my favorites. Every place I've lived has felt like home, but mostly because of other intangibles, not always the place itself. I never thought our little apartment in Germany would feel like home, but after our first trip back to the States it really did.
Next time I'll go into the qualitative benefits of renting or buying, and follow it up with the quantitative analysis. If I missed any misconceptions please let me know.
39 comments:
I agree with most of your arguments. What you don't mention is that you're at the mercy of your landlord, who could be a decent person or not. In a rising rental market, renters may struggle to keep pace with rising rents.
I lived in the Bay Area during the dot.com boom. My apartment landlord refused to give me a lease longer than 6 months, knowing he could raise the rent every six months. With a 2% vacancy rate driving up rental costs (increasing 5% every six months), it motivated me to buy and fix my costs with a fixed-rate mortgage. I bought a condo, where most of the maintenance was covered by an HOA (which I influenced as a board member). Dues were managable and worth the trade-offs of maintenance costs.
The value of owning isn't in having an investment, it's in having housing security. If you can manage a fixed-rate mortgage appropriate for your income, in the long run you'll have greater housing security than if renting. As for fixing your plumbing, for some of us that's a fair trade if it means having the same house payment ten years from now that I have today.
So let's face it- owning is what everyone wants to do so they don't have to think:
about saving money- this is our largest investment, we will not have to think about where a majority of our saved money should go.
where to put our garbage- no more weeding out old furniture, toys, etc- just stick it somewhere in the garage, attic, etc.
what our parents/friends think- it's not only socially acceptable to own- it's expected. If you don't, you're a drifter or worse a loser who can't get their crap together enough to buy.
For me, it's the instability. I've moved 9 times in the last 6 years and I HATE it! I hate packing and hauling and planning and unpacking. It makes me unmotivated to even fully unpack. This last move I was 5 months pregnant and started having little contractions. My fantasy is that I'll find the perfect place and settle down and never have to leave again.
At the same time, I know myself. The reason I moved each time was for opportunity or "something better." If I had owned a place, I would be complaining equally about being "tied down."
There's pluses and minuses to both. Right now, I'm still renting, and I'd like to keep renting this place for the foreseeable future. I'd finally settle down and buy because of the baby, but with markets on the way down and the price they want for this place based on last year's numbers, I'm afraid I'd have to stay put for at least 5-10 years not to be up-side-down on this place.
As the others mentioned, owning is certainly a lot more convenient than renting, but that convenience comes at a price as we'll see over the next few years as home values crash. True, renters have to deal with instability and fluctuating rent, but it's well worth it versus losing tens or hundreds of thousands in home value over a short period.
It's gonna be a fun ride!
Home prices crashing don't much matter if you plan to stay in the same place for several years. In the old days, average people did not regard their homes as "investments," but shelter. The people who are in the best economic shape WRT housing these days are the people who bought their homes, paid off their mortgages and now pay only taxes and maintenance. Any way to slice it, owning your home free and clear is your best housing security.
The advantage of buying if you're a younger person is that your salary likely WILL go up over two or three decades, and you'll be farther ahead if you bought a house and stayed put with fixed mortgage costs.
It's not a good strategy to look at your house as your piggy bank, even for retirement, because you have to SELL it to realize a gain, and then what? You don't have a home to live in anymore and you're once again at the mercy of the market.
Average people should not think of their homes as "investments." By definition, "investing" is an activity of the wealthy, and they understand that one only "invests" what one can afford to lose. The financial services industry has made billions in recent years by persuading ordinary people that they too could act like the wealthy, and dabble in "investments." Look where it got us.
Fluctuating markets only matter if you're looking to cash out, which is the investor's game. If you're a renter, then it's highly likely that you're not a wealthy investor, but an average guy. And unless you make your living as a real estate investor, you probably won't get rich buying and selling your home, and you may in fact, put your shelter at risk.
I think Americans need to revise how they think about their homes. They are shelter, not investments, not piggy banks, not symbols that reflect some image to the world. Just shelter.
Of course owning is better than renting.
But most homeowners do not really own their homes; they paid for it using money they are renting from the bank. For most of us, the question is really: Is it better to rent shelter from a landlord, or to rent money from a bank?
To me, the key difference is that when you’re renting money from a bank, one day your rent payment stops. At that point you live rent-free (although not housing-cost-free).
A secondary benefit is that renting money is a hedge against inflation. Your last mortgage payment, after 30 years of inflation, is going to be a lot smaller in real, inflation-adjusted value, than your first payment. So over the course of thirty years, you actually pay less for rent every year.
However, you can only realize these benefits if you actually stay in your home long enough to pay it off.
Per Craigslist, Realtors and MB's are advertising the $7,500 first time buyer tax credit that isn't a tax credit at all but a loan...please flag these folks. Why do I flag 'em? Because they usually are accompanied by statements like, "It's stupid to rent, " you are throwing away your $ with renting", etc. It's actually a loan which I just learned last week. Why the hell do they call it a tax credit?
http://calculatedrisk.blogspot.com/
2008/08/wingin-it-at-irs.html
I think the key is buying a reasonably priced home that ends up not being much more a month than renting...
Lets say you buy a $180,000 house and put $36,000 (20%) down, that is $863.35 a month.
$863.35 + 1800 a year property taxes and 400 a year insurance = $1046 a month.
Take the tax interest deduction of $8,591.90 and subtract the standard $5,150 deduction and you get a $3441 write off.
$3441 / 12 = $286.75 a month, making your true mortgage payment about $760, which is not much more than a lot of apartments. This doesn't even factor in the amount you could write off from property taxes...
-If my calculations are off or I am wrong about something I apologize in advance.-
And $180K will get you a fixer 20 miles out so add to it $500/month in gas and....don't forget the $ for fixin' the place up...
I understand your premise but you must be talking about Burns, Oregon or somewhere else, though I am seeing some PDX homes under $200K, fixers, but hey, it's progress.
I can get me a great house in my hometown of Sioux City, Iowa for $180K but I could also rent to same thing for $500/month.
I think we have a ways to go before buying pencils out in Portland.
Don't be so hasty, Bearlee. For a mere 180k you could live in a cozy bungalow in Sellwood and walk to shops, coffee houses and restaurants.
MLS# 8031962
Gee, I stand corrected..you can get a lovely 492 square foot 'cottage' in Sellwood. Anyone wanna guess how big the lot is 'cuz I have never seen one listed as: Lot Dim: irreg--1700 sf
Maybe PortlandMaps will offer some interesting info...
7969 SE MILWAUKIE AVE (next to another busy street, Tacoma)
no sales history, triangular shaped lot approx is approx 1680 square feet if I am recalling my geometry correctly!
oh, and it's just a half bath. Anyone wanna call the realtor on their error?
Listing #8031962 looks like a good candidate for bulldozer practice, but then you would be stuck with that great 1,700 SF lot, yippie. If that is the best $180K can buy in a decent neighborhood in PDX then prices need to fall another 20-30% minimum.
Could you even shoehorn a "skinny" onto that lot?
Let's see now, if you put down 20% (36K of your hard earned money)you would have a house payment of around $900-950/month. That does not take into consideration the income you lost by taking the 36K out of savings.
Since rents appear to be falling I am quite certain you could find a better shack to rent for less monthly payments & still have access to your $36K. I would let my dog live there but he can no longer qualify for a loan.
Bulldozer?!?!?! I could have that shack down with a sledge hammer in a day or less!
Or we could salvage everything and build a nice doghouse for the previous anon poster
Geez, what do expect to get for only $365/SF. It even has running water & electricity. Glad it is located near restraunts since there does not appear to be any place to eat other than sitting on the couch. Used the mortgage calulator in the listing & came up with $1,132 monthly payments at 10% down & $1,219 at 3% down. Doubt if this shack could rent for more than $700/month.
I've noticed people repeat that 'rents are down' but from what I've found so far, for a 'nice' apartment the going rate seems to be about 800-900. There are some in the 700-800 range as well but, generally speaking, its closer to 800 or 850.
When I hit the $900/month mark I start thinking about purchasing instead of renting -- though I'm not sure if that's logical conclusion to reach. So I'm eagerly anticipating part two of this post.
But on that note, I think all the rents I've seen are a bit more than they were last year, and two bits more than two years ago.
If you guys know of some great deal I missing, I'd be keen to know where they are.
Check out craigslist, there are some good deals on rental houses showing up more frequently. Noticed a very nice newer house in Garden Home with around 2,200 SF which was advertised for $1,595 recently. Rents for 1-2 bedroom apartments & houses may be holding steady or increasing slightly. This is probably due to the demographics of the people moving to PDX (many of whom are young hipsters with little or no personal wealth & many with lower wage jobs). Good deals on larger homes are showing up more frequently.
The above noted demographics does not bode well for RE prices in PDX, as most new residents can not afford or qualify for most of the overpriced homes that are on the market.
I was hoping someone would mention the lost opportunity on the $36K down payment.
I put $5K into a typical mutual fund in 84 and it is worth $100K today, even in a down market. Can you imagine what $36K would have done over that time? Granted, that doesn't guarantee the next 24 years will produce the same result, but the fund has a consistent track record since 74.
I think it's funny how people say, "Well, you put $36K down....." like it's couch change.
And I can get that $100K in 24 hours with a phone call or the push of the send button.
I agree with the opportunity cost of putting 40k - 60k as a down payment but, not being much of an investor, I figure about 3.5% - 5% on that annually.
60,000 x 0.4 = $2400
$2400 / 12 = $200 / month
Lots of good comments. I'm glad to see that some people picked up on the opportunity costs of the down payment on a house. It's even more important in a declining market due to the effects of leverage. This opportunity cost is included in my calculator, which I will post shortly.
Lots of good comments. I'm glad to see that some people picked up on the opportunity costs of the down payment on a house. It's even more important in a declining market due to the effects of leverage. This opportunity cost is included in my calculator, which I will post shortly.
correction, that should have been $60,000 x 0.04 = 2400.
3.5-5% return on 60K? A dog mutual find will return at least 7% over the long haul.
Regarding rents trending down (my prediction though depends on the 'hood)): it will interesting what the new apartments like the 2121 Belmont, the Wyatt, the Ardea (formerly known as 3720 Bond/SoWa), the Lovejoy, the Alexan, and likely the Encore and Atwater Place, will have on rent. Supply and demand thinking tells me that rents will drop, I mean, how long can they keep asking $2K+ and let them sit vacant?
Also, I can think of four conversions close in on the east side that aren't selling and will likely be converted back to apartments. Their conversions to condos likely caused rent to go up by decreasing supply and now we will see the vice versa.
I had a casual conversation with someone today about my decision not to buy and he got this look on his face of horror. Then he went into that trance they go into where it's like you told them God or their puppy was killed.
The home ownership paradigm is one of the most durable in our culture. It's blasephemy to believe otherwise.
Tell me about it. We sold in May 2007, long story short: career change and baby made it unaffordable especially since we bought too much mortgage to begin with.
Anyway, my Mom in Iowa says I am now raising my child in a welfare apartment! She hasn't even seen the place and doesn't believe me when I say this Forest Heights' apartment is actually an upgrade from our old Buckman house. And now with baby #2 on the way the family is questioning when we are going to buy again. When I tell them my childcare expenses will likely be around $1500/month come next spring, more than my first mortgage, they tend to go quiet. Next time someone asks about buying I will be asking them to cover my childcare expenses!
Its true you can achieve higher rates of return by investing, especially over the long haul, but for the sake of debate I think its more conducive to leave that off the table. There are many ways to turn money into more money but anything outside of the most basic, universally available options would entail a debate of their merits which is outside the scope of what we're talking about.
However, 3.5% - 5% can be had by walking into any bank, at the drop of a hat, and its 100% insured. WAMU has a 5% 13 month CD at the moment. Banner will give you 4% on a standard savings account. So these are the numbers I factor with. (used to be over 5%)
Besides, over the long haul, lots of things are good investments, including houses. :) But again, this is a question of when and how to calculate the benefits (factoring in all sorts of crazy numbers) and detracting factors from buying vs. renting.
Comparing a CD account to a house "investment" doesn't tell quite the same story. Apples and oranges. A better comparison to a CD would be the cliche' "living in Mom's basement".
There's nothing difficult in buying a mutual fund. No riskier than a house if you don't buy a potato farming sector fund or other such junk. Right now, less risky than a house.
Don't forget the magic of compounding, cap gains and reinvested dividends, etc.
I didn't mean to compare buying a house to putting money into a CD. In fact, I kind of agree with some people here who were talking about a house not quite as an investment in wealth-creation but rather as an 'investment' in a steady place to live vs. paying for a place to live monthly (forever).
Still, buying a house for whatever reason costs a lot of money. Timing and other factors affect how much money one might pay for the same house. Part of that money is the down payment, which you won't be able to use to generate income after you've handed it over to the bank.
The reason I like CD rates, or other accessible rates, is to establish some very basic measure of opportunity cost for down payment.
You can factor in 7% or 10% or even 20% interest if you'd like, as perhaps you know of some great investments that you'd rather put your money into. It just means that in your equation (that is, for you personally), it is less advantageous to own a home while for me, in my equation, it is a few percentage points more advantageous.
For example, if you have some niche investments that will net you a 20% return, its unlikely owning a house would ever be a good investment because 20% return + compound interest will pay rent forever and then some.
However, this gets into the merits of different investments (real estate, CDs, bonds, mutual funds, Vegas) which I think is a different kettle of fish all together. I'm curious about this too. Maybe PDX Outsider should follow up with a multi-post series on personal finance... I think that would be pretty cool actually.
As a quick aside, I have friends who are losing thousands a month from their retirement accounts this year. I'm sure things will turn around at some point (long term) but its not the environment I feel like tossing cash into at the moment.
My main point though is that since we're talking generally, about some set of guidelines for *everyone* (regarding renting vs owning), it makes sense to use a baseline of measurement that anyone has easy access to. And anyone with a pulse can stumble into a bank tomorrow and get 4% savings account so that doesn't strike me as a bad place to start...
"People losing thousands a month from their retirement accounts". Yeah & if you have a house valued at $300,000 you are losing roughly $1,000 of value each month based of the declining values of roughly 4% reported by RMLS for PDX. Just because that doesn't show up on a monthly statement doesn't make it any less of a reality. Also I believe the RMLS figures are understated since sellers concessions of 2-3% are prevelant on most transactions. More like a 6-7% decline would be more realistic. Also most retirement accounts don't have a 6% commission to pay when converting securities into cash.
Around the holidays....portland will be a 'renters market'. If you want to rent nice homes...hold off until the holidays and the turn of the new year. So many houses on the market right now. Sellers will get tired, need to move before their home sells etc. They will rent their home. The renters market will become saturated thus lowering rent prices across the seattle / portland area. Just an fyi...
I drive through several residential areas to get to work and I've seen many houses that have been taken off the market and are now for rent.
I know the housing market is down right now but the people feeling it most bought in during a period of fevered purchasing because 'prices only go up' or they withdrew too much equity during the same period.
If you bought a house ten years ago it is "down" in value too, compared to one year ago, but its irrelevant because over all its up a good deal. Say for example a For example, $150k home in 2000 now worth $260 now (valued at 300k a year ago). But I'm really not interested in it from a 'wealth generating' point of view because all that money the house 'made' is 'virtual' money since you can only access it by going into debt or moving out.
When you lose money in an investment fund you are losing actual money. When your house goes down in value 4%, you still get to live in it. Unless you're using your house as an ATM, a 4% drop (which is a hardly unforeseeable correction after ridiculous spike) shouldn't matter if all the other numbers work.
If my car were worth $10,000 one day and $5,000 the next I'd still have a car, and if I bought it for $4k I'd be pretty happy. Not as happy as if I'd cashed out at $10,000 but then I'd have been on the Max (or in a FlexCar) for a year waiting for the Ford-market to correct.
The market (housing and trading) is a bit bumpy at the moment. I wouldn't be keen to throw money into either unless the numbers worked. The stock market, if it crashes, you have less or nothing. If the value of a house crashes, you still have a house to live inside of. So as long as certain numbers pencil out, you're not looking for an ATM or to 'flip' the place, buying a house is not a bad idea...
**IF** the numbers work. We'll see what the numbers are soon. I'm getting really curious to see what PDX Outsider's methodology is.
Yes, rental *house* prices are down!
Yes, rental *apartment* prices are up!
I don't know how long these trends can continue before they begin to track together again.
I lived in a really nice 3 bedroom apartment in Vancouver that rented for $1125/mo. They raised the rent by $90 right about the time I was moving. I told the manager (Guardian Property Mngmt.) that the price was getting two steep and I was sure I could find better, but she replied that they were raising rent at ALL their apartments since they expected higher demand. I've since heard this echoed on blogs and in news stories: apartment management companies are making a calculated market bet that demand will go up.
On the other hand, I see house rentals going down, down, down in price. I was looking at a 3Bd, 1Ba being rented out by Fish Construction for $900 (what's the matter Jeff, couldn't sell it after the rehab?) when I realized I was a fool to still even be considering an apartment. House flippers, rehab-ers, and construction companies can no longer wait it out and bet on the market like the apartments managements. They are ready to rent NOW!
We ended up with a 5br, 2ba in close in NE for $1500. They couldn't sell and needed income.
"We ended up with a 5br, 2ba in close in NE for $1500. They couldn't sell and needed income."
We saw a lot of these already back in Dec 2006 when we moved here. I can only imagine it's gotten worse (or better, depending on your take!).
That sounds like a pretty good deal to me.
Real estate traditionally has been a good investment over longer periods of time, say 10 years. However, many people do not stay in the same house for 10 years. Reasons may include job transfers, divorce, having kids or most recently foreclosures. For those who bought in 2006-07 (which is a significant number) & now reach a point where they must sell, there is going to be some bloodletting. Also since the basis for residential real estate has always been leverage, this creates a problem. Say you put down 10% on a $300K home ($30,000)now your home is worth $282,000 ($18k or 6% decline as per CS). To sell you have to pay a 6% RE commission ($16,900). Now your $30,000 original invest is wiped out & you still owe $4,900. That does not include the 2% or so that you lost upfront in paying closing fees. That can not happen in stocks unless you bought on margin.
So if you don't have to move you could still live in your house & not worry to much about your lost investment. It may take many more years to recoup your losses but what the heck you are still making payments to the bank, the county for taxes & the insurance co. for fire insurance. Pretty good bet that that total PITI payment is much larger than renting a comparable home.
As for the people who refianced over the last 4-5 years. I believe there are a signifcant number who increased their loan balances to subsidize their lifestyle of living well beyond their means. Also apprx 25% of loans made in 2006-07 in the PDX market were Alt-A. These are showing signs of being just damn near as bad as subprime. Look for foreclosures to soar in PDX over the next 6-24 months as the parachute of appreciation in PDX has evaporated.
PS, Another reason for having to sell is job loss. With unemployment rising this will affect more & more people. Also based on a 10% loss my stock portfolio is now still worth $27,000 & I have lost only $3K. I can sleep a lot better in my rental house than someone who has lost $35,000 on their home.
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