Why It May Pay To Rent Instead of Buy

Why It May Pay To Rent Instead of Buy

[ad_1]

Key Takeaways

  • A new analysis of the renting-versus-buying dilemma found that renters usually can come out ahead.
  • The key for renters to build wealth is to take the excess money they otherwise would spend on housing and invest it in the stock market, ideally in a low-cost index fund.
  • The economist’s analysis comes with a major caveat: It all depends on timing. Currently, he judges the stock market to be overvalued, so he’d buy a house instead.

When it comes to real estate, you’ll usually, but not always, come out ahead by renting instead of buying—but you might need to get a degree in economics to tell the difference.

That’s the upshot of an analysis released last week by Brad Case, chief economist at Middleburg Communities, a property management company based in Maryland. In his paper, Case pushes back against the conventional wisdom that, all else being equal, it makes more financial sense to buy a home than rent one. 

“You are making a decision where to deploy the money that you have. And when you’re talking about buying a house, you’re talking about a big pile of money,” Case said. “The basic question is, are you going to sink it into a house, or are you going to put it into a better investment?” 

Case’s paper is a salvo in the age-old debate about whether it’s better to own the place that you live, or just pay rent and let a landlord deal with all the expenses and hassles that come with property ownership.

Stock Investment Better Than A Downpayment?

The crux of Case’s argument is that if you take all the money you would have spent on a down payment and other ownership-related expenses, and pile it all into the stock market, you’ll have much more money 30 years later than you would if you had invested it in a house, because over the long term, stocks generate much higher returns than housing—7.6% a year over the last 50 years, versus 5.4% for houses.

The argument for buying usually goes like this, and makes a great deal of intuitive sense: When you sign a rent check, that’s money you never see again. When you pay your mortgage, you’re building equity in a house that you can later sell, or borrow against. The only part of the payment you lose is the interest. And because home values tend to increase over time, the roof over your head doubles as a sound investment. Indeed, most of the wealth of middle-income families is in the form of a home, according to data from the Federal Reserve. 

As Taylor Marr, former deputy chief economist at Redfin, put it in a May renting-versus-buying analysis, “When you own your home, your home pays you; when you rent, you and your home pay your landlord.”

However, the usual arguments in favor of home ownership miss two major points, Case says. First, renters save on a lot of expenses that homeowners have to pay, including maintenance and even things like pool and gym memberships, which are commonly included in higher-end rentals.

Second, buying a house often requires a huge investment of cash up front that could otherwise be invested in stocks. Assuming a 20% down payment—the amount needed to avoid paying mortgage insurance—buying the median-priced home would require putting away $78,360, going by data from the National Association of Realtors. And when it’s time to sell the house, you’ll have to pay commission to a real estate agent, usually around 5-6%.

In his analysis, Case compared two buyers with the same income, one who bought a median-priced newly built house, and the other who rented the median-priced apartment. The renter plowed the down-payment money, as well as any extra saved by renting instead of buying, into a typical investment portfolio of 69% stocks and 31% bonds.

Timing is Critical

Who comes out ahead? It depends on when the comparison begins, because the stock market and housing market have varied significantly. Over a 30-year period beginning in 1982, the homebuyer ends up with a net worth of  $703,398, while the renter had $858,990, putting the renter ahead by $155,592. But if the contest began in 1972, the homebuyer would be ahead $340,154 to $280,181, a difference of $59,973.

For most years across most of the 50-year period Case analyzed, the renter would outperform the buyer, especially if they picked a low-cost stock index fund instead of a mix of stocks and bonds.

And renting has another advantage, which is that a renter can move more quickly than a homeowner, and therefore can take better advantage of higher-paying job opportunities in faraway cities.

“It’s very important for young people to be getting lots of money invested into the stock market,” Case said. “Renting enables them to do that, and buying a house does not. It’s as simple as that.”

Case’s examples illustrated, however, that it’s not always actually simple, especially for an average person who lacks a doctorate in economics to figure out. Largely it comes down to whether stocks are over- or undervalued at any given time, Case said. And that’s impossible to know for sure until after the fact. 

“If the stock market is favorably valued, then buying a house is a stupid waste of your money because you would do better investment-wise by putting that money into the stock market instead,” Case said.

As for right now, Case said he’d buy a house instead of renting if he was just starting out, because he considers stocks to be overvalued at present. That’s the same call he made in 2000, when he bought a house, a decision he hasn’t regretted.

The upshot of Case’s paper isn’t that one decision over the other is always right—after all, everyone’s situation is different, and the home you want to live in may only be available to buy, or to rent—but that it’s not the no-brainer it is sometimes portrayed as.

“It’s very important to be thinking about homeownership and renting in the context of a bigger financial management issue,” he said. “The people who say obviously you need to buy are simply wrong. It’s not obvious. It’s never going to be obvious.”

[ad_2]

Source link