I have spent a lot of time thinking about and researching home ownership. I initially thought that homeownership was always the best choice, then recently began to see the advantages of renting. I can now say definitively that one is not better than the other. Rather, at different times in cyclical economic conditions it can be advantageous to be in one or the other.
Property Taxes an obstacle to true Ownership
I have long loathed property taxes as the sole obstacle to owning ones home and land outright. I used to believe that if you can ever pay off the mortgage then you will be sure of a roof over your head no matter what. Yet as most already know, I now understand this is not a realistic expectation. The truth is ownership does not mean you can do anything you want with your property either. Ownership has drastically changed throughout history. Even in feudal times land was granted by the king and in return the landholder had to work the land, growing crops to return to the king ton continue having use of the land. We have a similar system now in that what we think of ownership is really a set of rights. I think its better to look at land ownership as the right to use.
Government code and policy on property Rights
Many would argue that once you own a home you can do whatever you like with it. There are many levels of freedom that you can enjoy and customize your home to your delight, but these actions must fall within the guidelines of the rights you have of use. There are many things you cannot do without prior approval, permits or fees. This is due to city zoning laws, city permitting requirements, community CC&R’s, and other ordinances. Many people would argue if you found an oil deposit or gold inside an apartment complex common ground you wouldn’t have any right to that, but amazingly if you owned a home and found in your backyard chances are you would not either. This is due to the distinction of mineral rights, which some property owners may have, but the majority likely do not.
Now that we have made the distinction between ownership and right to use let’s look again at the difference between buying real estate and renting. Almost any form of real estate can be rented so if you buy a single family house, because you don’t want to live in an apartment this is not a great argument as someone can just rent a single family house as well.
Say a new neighbor moves in next door that you cannot stand, or you have a better job opportunity in another state you can make the move very easily.
Advantages to Owning
- Emotional satisfaction in pride of ownership
- Can customize
- Can save money doing maintenance yourself or defer it altogether if cash is tight
- Cannot be evicted for no fault of your own as long as you pay mortgage and property taxes
Advantages to Renting
- Can easily move for better job opportunities or if you no longer like the neighborhood
- Wide range of properties available in many price ranges
- No opportunity cost – Can invest in higher yielding assets
Owning A Home as a Financial Instrument
The only striking difference between owning real estate and renting is in the term of ownership and cost. Essentially thinking of housing as a financial instrument.
Earlier I argued that whether you rent or own your home your actual experience does not differ all that much. I know people tend to think of ownership as a well maintained house with a private yard and renting as a crappy apartment with noisy neighbors. Please remember that anything that can be owned can be rented so you must make comparisons between comparable structures only. IE buying that nice house with the private yard or renting that same exact nice house with a private yard. Now generally speaking over time it costs more to rent that place than it does to buy. This is why people make the original comparison as someone who can’t afford to buy probably can’t afford to rent the nicer place. Again this is not a hard truth, but where people tend to make generalizations that leads to poor decisions.
If you could only keep any extra savings you accumulate in a bank account paying 0% interest I would tend to agree that everyone that possibly can should buy a house right now. As well understood this is because overtime the principal is being paid down and effectively locks in your housing costs other than property taxes, maintenance, and insurance. However, that extra savings you have does not only have the alternative option of 0%. It can go into stocks, bonds, real estate, gold, bitcoin, fine art, or even real estate that you rent to someone else.
The less you put into your home, the more you have available for other higher earning assets that will increase your retirement income. So I believe we have to question the argument that owning a home is always being better due to its protection from rent increases. Rather this protection comes at a cost of your initial down payment and annual property taxes. This money could instead earn a return in other investments.
In a simplified example you can put your money in a house and lock in the majority of your right to use costs for life. Or you can rent a place and own stocks and bonds and use the investment income to pay for rental rate increases. What needs to be understood is that owning your home is really owning a financial instrument that you live in.
When Living in a Financial Asset Makes Sense
Let’s dive deeper into what it means to purchase a financial asset you live in. I believe real estate is especially popular for cliches such as, “They aren’t making any more land” or something to the effect that even if its a lousy investment you can get utility out of it. While, at first glance these points make sense, but they only make sense at the right time. Just like buying stocks in 2007 would not have been close to as lucrative as to buying stocks in 2009. Because a home is a financial asset it is dependent on the market participants to derive value.
Judging a fair price from rental Rates
Now there is no way to predict the future, and if anyone tells you otherwise please be cautious to take their advise, there are ways to help judge if it is a good time to buy. I think the simplest way is to look at rental rates. Rental rates move up and down just like home prices, so there are no guarantees, but they can help compare value. For most of us we need to have some sort of shelter and we have two options: rent or buy. For fun remember if you buy a house with a mortgage you are renting the money to buy it. Again we will assume the rental property is the same exact property that is for sale. In this example if you don’t buy the house an investor will and offer to rent it back to you.
Example comparing buy vs rent
Assumptions: The monthly payment for purchase will include principal, interest, property taxes, HOA if any, and maintenance. Down payment is not included in this figure. These are things to think about when you make your comparisons.
Example 1: Comparable rents are $2,000. The house is for sale with a monthly payment of $2,000
Example 2: Comparable rents are $2,000. The house is for sale with a monthly payment of $3,000
Example 3: Comparable rents are $2,000. The house is for sale with a monthly payment of $1,800
Example 4: Comparable rents are $2,000. The house is for sale with a monthly payment of $1,200
In these simple examples which would be better to buy or rent. Example 2 obviously would be better to rent and in most cases example 3 and 4 would be better to buy. But what about Example 1? It is emotionally too easy for most including myself to justify making the purchase because it is the same cost per month, but remember we did not include the 20% down payment. If we rented instead in example 1 we would have 20% of the purchase price available to us to invest in stocks, bonds, or anything else. Whatever the return from those investments could be thought of as subtracted from the $2,000 in rent and thus give a lower housing cost than the purchase.
Now let’s take another look at example 3. If the proceeds from other investments were $201 or more then even with a total monthly payment that is lower than the rental rate you would be better off renting in this situation. If you cannot find or trust any other asset to earn a positive return then by buying the home you will help reduce your monthly housing costs. However, it is conventionally warned against to have all of your money in one financial asset.
This is a very simple example, and again rents could adjust up or down, and end up making what you thought at the time was a good purchase turn out to not be as ideal. It can at least keep you from making an initial purchase that you know is not a good deal.
When buying makes Sense
If a situation arises where you can purchase a home for a total monthly payment well below rent then ownership could be beneficial to you. If home prices later increase to the point where current rents are much lower than the new total payment based on a purchase price from the new level you could do well by selling your home, collecting the proceeds and renting until this flip back in favor of ownership again. However, the transaction costs are very high when buying a selling a home and with no guarantees of the success of this maneuver it could be more trouble than it is worth.
Instead I think its best in practice to maximize investments in other liquid assets such as stocks, bonds, gold, and rental real estate and only buy a home if you can easily afford it and it offers you a deep savings to comparable rent.