Do you want to spend your entire life living in someone else’s home, working 40 hours a week just so you can hand them a third of your salary and not own a thing? I certainly don’t, but there are quite a few people who believe this is the way to go.
A few weeks ago, I had a conversation with a couple who regretted buying a home and wished they were still renting. The cost of a mortgage and other home ownership expenses were higher than they had anticipated, and it would be cheaper for them to rent instead.
I responded that studies have shown it’s actually cheaper to own a home than rent in almost every city. Almost immediately, I was met with two heads shaking slowly in unison and a matter-of-factly “No, it’s not.” They countered that it was more financially beneficial to rent a home and invest the alleged “savings” in the stock market. This would produce a much higher return than the equity in a house ever could — homes appreciate one to two percentage points above inflation each year, while the S&P 500 provided an average return of over 10% from 1991 to 2011.
It was an intriguing concept, but one that just didn’t sit right with me. And the more I thought about the assumptions that would have to pan out for this scenario to really work, the more I doubted it.
Is Renting Really Less Expensive Than Buying a House?
I decided to do my own comparison of how much it would cost to rent versus finance a home purchase, and momentarily live out the fantasy that I actually had saved up the necessary down payment needed to finance a home.
In order to keep the analysis as realistic as possible, I chose to compare one home for sale and one home for rent in the city of Torrance, CA — a town in the South Bay area where I would gladly live — where home prices are still inflated as is expected in Southern California, but not so close to the ocean that both rent and mortgage costs are through the roof.
According to Zillow, there is a 2 bedroom, 2.5 bathroom, 1,186 square foot house for rent on Plaza Del Amo for $2,295 per month. Including the $115 I spend on utilities every month and tacking on renter’s insurance, I’d be looking at a total cost of around $29,100 per year to live there.
The next block over on Merrill Drive, there is a place for sale that offers a very similar two bedrooms, two bathrooms and 1,250 square feet for $349,000. I used Zillow’s mortgage estimator to find out what it would cost to finance the property. Based on a positive credit profile, this was my best result:
Of course, comparing rent-to-mortgage isn’t apples-to-apples. In addition to an annual mortgage cost of $17,160 based on the results above, I must also include estimated yearly utility and maintenance expenses totaling 1.5 percent of the home’s value, or $5,235. There’s no way I’m joining an HOA, so that brings the total annual cost of home ownership in this case to $22,395.
So where are the extra savings I’m supposed to receive from renting?
10 Reasons Why I’d Rather Be a Homeowner
1. Renting isn’t cheap anymore.
According to a recent MSN article, rents are skyrocketing, especially in comparison to falling home prices. The following cities were identified as having the sharpest rent increases last year:
- San Francisco, 14.7%
- Oakland, Calif., 11.2%
- Denver, 10.9%
- Miami, 10.5%
- Boston, 10.3%
2. Buying a home isn’t expensive if you’re honest about what you can really afford.
The couple in question bought their home in Culver City, CA, a neighborhood where the income to home value ratio is so high, it’s actually a more expensive place to live than Beverly Hills. Not to mention, they are paying an outrageous HOA fee of $400 per month. Obviously, home ownership for the two is not expensive out of necessity, but due to lifestyle choice.
3. You can pay off a mortgage — you will pay rent until the day you die and own nothing.
Renting might sound pretty good — until you realize that you will pay rent forever, and spend hundreds of thousands of dollars with nothing to show for it.
If you buy your home, at some point (if you’re smart), you will pay off your mortgage. Then the only expenses left are taxes and maintenance.
Sheri Rice, a marketing director in Fitchburg, Wisconsin, agrees that the stability of owning your own home is much more rewarding than renting. She lists a few of the benefits as “low payments, a roof over my head to call my own, an asset to sell should I lose my job, and someplace to own outright. Not to mention there is a different vibe in neighborhoods where people own. Renters don’t take care of the property as well — perhaps because it’s not theirs.”
4. Renting is more flexible? Seriously?
When you own your home, you can stay as long as you like. You can have pets. You can paint your living room hot pink. Granted, belonging to a Homeowners Association would limit some of the cosmetic changes you can make to the exterior of your property, but inside, you are king of your castle.
Renting, on the other hand, essentially puts your life in the hands of a landlord, a person who cares very little about your well-being. It doesn’t mean landlords are bad people, it’s just that your home is their business. Landlords can raise rent or kick you out if they so choose. Some do a shoddy job of maintaining the property. Many are unpleasant to deal with.
And God forbid you spill red wine on the carpet and lose your security deposit.
5. You can still leverage equity to invest.
Rent and invest or buy a house instead: Who says it has to be one or the other? Unless you’re one of the poor suckers who purchased their home at the height of the housing bubble, your property is gaining equity, and you can leverage that equity to invest.
Today’s cheap mortgage debt makes it an ideal situation for investing, too. Of course, this is a risky option, but so is putting your life savings into the stock market anyway.
6. Everyone mentions the housing bubble burst — what about the stock market crash?
Whenever the subject of homes-as-investments comes up, the housing bubble burst is always pointed to as evidence that homes make bad investments. Did we all forget about what happened in 2008? According to U.S. News, 401(k) investors lost 14 percent of their retirement savings on average. Wealthier employees had more to lose — portfolios dropped by about a quarter in value.
Even seasoned investors broke the cardinal rule of investing and panicked, pulling out when the market was at it’s lowest, preventing their portfolios from regaining losses once stock values recovered.
7. Most individuals don’t know how to invest properly.
Which leads to one of the most important points: The average person (i.e., you) just doesn’t have the knowledge or emotional objectivity to invest in a way that will match or outperform historical stock market performance.
Research firm DALBAR publishes their Quantitative Analysis of Investor Behavior every year, which examines the performance of individual investors as compared to market indices. Below is how well the average investor does at “beating the market.”
The accuracy of DALBAR’s methods has been questioned, but their findings do highlight patterns that indicate most people aren’t adept at making smart investment choices that will grow their returns at the same rate as the market.
8. The “average” stock market return isn’t actually anywhere near 10%.
Average annual returns make market performance look a lot better than it really is, and the more volatile markets are, the more that number gets skewed.
Take this example from Forbes:
“Let’s say you owned a single stock that was valued at $100 and the market increased by 100% in the first year and lost 50% in the next year. 100% minus 50% divided by 2 would give us a 25% annual average return and we would expect our value to be $125. But in reality, the $100 would have gone up to $200 ($100 plus 100% increase) and then dropped back down to $100 ($200 reduced by 50%), leaving us with exactly as much money as we started with for a 0% return.”
Annualized returns will factor in volatility, and are thus lower. Then consider that most investors don’t place a lump sum investment in the market each year, but spread their contributions out a bit at a time. There are also fees and commissions associated with each trade, which take an additional bite out of investments. And don’t forget about inflation.
Oh, and you also have to keep paying rent.
9. The whole premise is based on the huge assumption that renters will actually invest.
We humans have a tenancy to succumb to lifestyle inflation — the more money we have, the more expensive our lifestyles become. Let’s be realistic: The money renters could put toward investments will likely be spent on car payments, bigger TVs and premium cable, instead.
Rice agrees, “My personal experience with buying a home, and also several years of renting in my twenties, is you live right up to the limit of what you can afford — so very few of us have the discipline to save and/or invest whatever money we save short-term.”
10. A home is definitely an investment, just not a financial one.
Mathematically, the person who rents and invests will probably come out on top as far as return, assuming they can actually find a place to rent that is cheaper than buying. But this is real life — people don’t live according to equations, nor can they predict the future. We have families, we seek security. Homes can provide so much more than equity.
Jonathan DeYoe, CPWA & AIF, of DeYoe Wealth Management explains that just because a house shouldn’t be considered an investment, doesn’t mean owning one is a poor financial decision,
“It is my refuge, it is where my kids were born and will be raised, it is where my family congregates and where my relatives visit. I can paint, rebuild, move walls, change the garden, do whatever I want to accommodate my current family needs and any future family needs because I own. No one can kick me out or force me to move. Ownership gives me more control. Control allows me to make better plans for my family’s future. These are not financial reasons specifically, but they support my life and my family’s financial plan.”
I’ll take the trivial American Dream ideal of home ownership — white picket fence included — over a crappy apartment and stock portfolio any day.