How much will your home rent for?
One of the biggest decisions anyone could make in their life is whether to rent a home or to purchase one. Conventional wisdom has always told us that it’s better to buy, as well as Real Estate Agents who claim that it’s “always a good time to buy”.
As most of us have realized by now, Realtors can be dead wrong. After all, they’re salespeople, and it’s in their interest to tell people to buy. If you were so unfortunate as to have believed these Agents and bought a home in 2005, your home is probably worth much less than what you paid.
If we can’t believe Real Estate Agents or the conventional wisdom of “ever-rising home prices”, how can we determine whether it’s better to rent or buy?
First, a Brief Summary:
1. Owning a home requires maintenance, property taxes, and insurance. Renting is clearly cheaper on a monthly basis.
2. Owning a home gives you a tax break on the interest paid, as well as the property tax. If you’re in a high income bracket, you get more relief from this. Whether it’s enough to offset the savings from renting, can be a complex equation.
3. Owning a home is a big commitment, and there is much less flexibility in regards to moving. Having to sell your home or rent it out every time you move, can be physically and financially draining.
Let’s explore the primary variables in the Rent vs. Buy scenario:
If you’re planning on moving around every 5 years or less, it may not be a good idea to purchase a home. There are transaction fees associated with selling a home. Usually 5-6% go to Real Estate Agents, as well as other expenses. It’s a bit risky to try and time the market, and you could end up taking a hit if your particular market does not perform well. If you’re planning on having flexibility without the risk, renting is in your favor.
If you’re an investor who plans on making a sizeable return on your money, then renting may also play in your favor, but it depends on what kind of returns you’re aiming for. Let’s say for example, if you could make a 10% annualized return on your money, it may work out better to invest it elsewhere rather than putting it on a down payment, along with paying maintenance costs, property tax, and mortgage payments.
If you aren’t an active investor seeking sizeable returns (greater than home interest rates), then buying a home will eventually work in your favor, in the long run. Not only will you eventually pay down your home, but you can have “fixed” payments, while rent prices are guaranteed to inflate over time.
This is probably the single most important aspect of the rent/buy scenario. If rent prices are substantially lower than what your mortgage payment would be if you purchased the home, you may be better off renting and investing the rest of the money elsewhere, or even just saving it until prices are more in tune with rents. Fundamentally speaking, renting should be slightly cheaper than owning a home.
When housing is too expensive and there is a huge gap between rent prices and mortgage payments, it’s NOT a good time to buy. The rent/buy payment ratio is an important indicator to keep your eye on, and there is much data out there for your gathering.
If interest rates are low, you will obviously have a lower mortgage payment. However, keep in mind that when interest rates rise again, home prices can fall drastically. If this happens and you’re prepared with cash, you can take advantage of those lower prices by plopping down the cash and borrowing less. You’ll also have lower property taxes, since the home is purchased at the lower price.
Homes go up in value, but so does everything else. Living in a home will not make you rich. If your home even doubles in value, you can expect the homes around you to have doubled, as well as the prices of everything else.
Adjusted for inflation, homes generally appreciate about 1%, historically. Most would consider this to be a lousy rate of return, but remember that a home is a place to live – not merely an investment tool. In fact, it can be argued that a home is a terrible investment, considering the inflated home prices, rent price competition, and all the maintenance headaches involved with home ownership…all for such a small rate of return.
Many variables come into play when deciding whether to rent or buy, but what we described above are the main variables that should affect your decision.
Some other variables to consider are: Fees of home purchase, home insurance costs, property tax rate, maintenance costs, rental deposit, and estimation of rent price increases. Don’t forget to factor in rent price inflation.
Do Your Homework!
There are many rent/buy calculators that can calculate the opportunity costs for you and can help in your decision.
“Average Rent Price” stats can be pretty bogus and misleading, because cities are comprised of different neighborhoods and there is sometimes a great variance in price between them. There’s too much volatility to simply take a “city average” when it comes to rental home prices. You should compare rent/sale prices on your own, using houses that are similar and located in similar neighborhoods.