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March 07, 2012

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I keep seeing this on various blogs lately. Since most of the PF blogs are owned by the same handful of people, who likely have an agenda beyond blogging, it makes sense that they would present a unified message in furtherance of that agenda.

Aren't they just giving the opposite advise that was being given when house prices were high, and then saying that the advice given back then was wrong?

So now that prices are low its time to rent?

Seems like if someone wanted to buy houses cheap and turn them into rentals they might give advice like this.

And back when prices were high and they wanted to sell houses that had appreciated they might have given advice like they gave back then.

Move along, nothing to see here...

What's my take on the issue? If their analysis was true the average net worth of renters would be higher than owners. That is not the case. In a perfect example where no other external factors come to play and 100% of the savings of renting in a market where ownership costs have out paced rental costs are used for other investments then their theory holds true.

In reality their theory is a major fail.

I imagine we'll see a lot of articles like this while we're in the process of one of the worst housing slumps in history. But like everything, housing will eventually come back, and we'll start seeing articles that espouse the exact opposite philosophy.

Housing is an investment (whether you intend to make any money or not) and if you follow most investing principles now would seem like a good time to buy -- not rent.

I have seen this analysis already in the past and immediately saw through their lack of rigor at that time.

They have a major flaw in their analysis. When talking about owning and getting to breakeven they are trying to get you to a breakeven where it costs you zero to live in that property and if they can't get to a zero cost of living then they claim renting is better.

Anyone see a problem with this? Yeah, its pretty obvious. Renting is not a zero cost of living proposition. They should be comparing ownership to renting but they are comparing ownership to living in your parent's basement for free.

Frankly this analysis is ridiculous.

There are, of course, a lot of non-financial reasons to own - you have complete autonomy over your home (well, to the extent local rules allow), you don't have to worry about a rent increase or the landlord deciding to sell the property and evict you, the satisfaction of home-ownership and maintenance or gardening or whatever it may be...And, over the long term, housing values will keep up with inflation whereas rents will go up with inflation.

I am a renter because it makes financial sense right now with the situation we're in, and we're putting all of our investment capital to purchasing homes to rent to other people.

Great point Apex, I'm ashamed I didn't notice that myself.

I should also point out that most housing stories that try to talk about things on a national level are problematic because housing is such a regional issue.

I bought a house 2 years ago in the New England area and my monthly payments (P&I, property tax, insurance) are $1,000 less a month than what I was finding in rental prices. If you subtract the principal portion from this amount then it swells to $1,600 less a month. That covers A LOT of upkeep and I'm still making money on owning each year.

Plus, I like my house better than any of the rentals I looked at.

Along the lines of what Apex says:

Factoring in a 30-year mortgage, $1,200 in annual home insurance, closing costs of $5,500 and maintenance costs of $100 a month, along with property taxes, he calculated that it would take a selling price, 10 years later, of $395,404 just to break even.

By 'break even' does McBride mean

'costs the same as renting'

or does he mean

'effectively costs you zero'

?

MattJ - I just ran some simplistic numbers based on the example and came up with the following:

Assuming a $200k purchase price, 20% down ($40k), 6% fixed rate 30-year mortgage, this buyer would have monthly mortgage payments of $959. Monthly out-of-pocket is $1359 after $1,200 annual insurance and $100/mo maintenance and assuming $2,400 annual taxes. After 10 years, he'd still owe around $133,000. I'm ignoring the annual tax benefit of mortgage interest deduction.

He puts in a total of $45,500 upfront, then pays $1,359 a month in all homeownership expenses. In 10 years he sells for $395,000, making approximately $261,000 on the sale. This is a return of 3.62% annually - much better than any savings account right now. And with renting you are instead putting that $1,000+ a month for a similar house right down the drain.

It's all about TIMING! That's the history of all Bubbles.

I remember back in the halcyon days early on in the great real estate bubble we would often sit around at work and discuss the upward rise in value of our homes. Being engineers we would calculate what salaries would have to be to keep it going and we came to the conclusion that the rise was unsustainable since our home values were going to the sky but our salaries were not because overall we were not in a period of ultra high inflation.

Our first home in 1963 was a brand new 4br. 2ba. California ranch style in a subdivision populated with young families just like us. I was 29, had been in my job 3 years, and the home cost $26,950. We were so proud of our dream home that we overimproved it with top of the line carpets and drapes, expensive furnishings, and custom landscaping and patios. Within a year we would have needed to sell the home for $34,000 just to break even. They were still selling homes just like ours for $26,950 so if I had been laid off and forced to relocate we would have taken a big loss. As it turned out my job was safe and we stayed in the home until 1977 when we sold it for $89,950.

We then moved a mile to development of large custom homes and bought a 5 year old home for $107,500. That home continued to appreciate rapidly and by the peak in 2006 it was valued at $1.2M. Today it would sell for $1M.

The people that got themselves into a mess were those that used their home as a Piggy Bank and kept taking out additional loans to send their kids to private universities, or buy second homes, boats and RVs etc.

Latecomers to the Bubble wanted a gorgeous home but couldn't afford it. Their solution was to sell their tiny home in Silicon Valley and move about 50 miles to a farming community like Stockton where land was cheap and builders were putting up Mega Mansions that they could afford. They were happy in spite of the very long commute every day. Then came the collapse of the bubble along with the loss of many jobs, and homes in Stockton dropped to 30% of their former value - Calamity!
What has propped up the home values where I live is the value of the land. There's only so much buildable land in Silicon Valley and the majority of it is already built on - the orchards, canneries, and small farms disappeared in the 50's and 60's.

If you buy a house that is well within your means (and by "well within" I mean you have enough resources left to fix it if something major breaks, and it's not so huge it impoverishes you with furnishing, utilities, and maintenance costs!), and you stick with it for the long haul, I don't see how renting has the advantage in the distant long-term in most cases. But good timing does help, as others have pointed out. Buy the wrong house at the wrong time, and it can easily make you very poor, even in the long haul.

The way I see it, after tax breaks, our house costs us several hundred dollars a month less than renting a comparable property in our area. And at the end of the mortgage, you own the house.

That said, I don't see our house as an "investment" in the strictest sense. It is more of an inflation hedge against higher rents in the future. And if I didn't have a family, I would probably be renting an apartment a third the size of my house, not worrying about maintenance, and investing the difference - and I probably would end up richer.

I disagree with that. While I don't think you can get wealthy either way, I think ownership has many benefits over the long run. The problem is people think short term and not long term.

Right now I pay roughly $1,900 a month in mortgage, taxes and insurance for my house. If I rented, it would probably cost $1,250 or so. So that's a $650 difference in favor of renting. Except that with my interest rate I'm adding $1,000 of equity into my house each month. With renting, I get no equity. My payment will slightly increase with property taxes and insurance increases, but the bulk of my payment (principle and interest) will remain steady for the life of my loan. Plus, at the end of 15 years, 80% of my payment goes away when the mortgage is paid off. Not so with renters.

Yes, I know that there are other things at stake. Renters can invest that $650 I spoke of earlier and make more money. I have to pay for maintenence and improvement. That's all fine. At the end of the day, I still think owning a home is the way to go. But, that's just me.

I say, do what makes you feel financially secure. For me it was time to purchase. I payed off my CA home (currently renting out) two years ago. My rent here in FL increased each year 5% and buying a house made sense. I saved up $30k over the past four years for a down payment and managed to find a steal on a house in this low market.

Moved from an 790 sq ft apartment ($900 rent) into a 1375 sq ft 3bed/2bath 2 car garage for $506 a month including insurance and property taxes. 15yr @ 3.25%, $50k mortgage.

I'll pay extra to get the mortgage paid off as soon as possible... mostly because I feel safer with $40k in reserve and no payments. This will provide me with two homes, at which point I hope to look for another home (modest in size) for my next 5 years and then pay it off and rent it also. I figure if I can keep doing this, I should have three rentals and a fourth house to live in.

Do what feels 'right' to you and don't rush it. To each their own.

Great blog, thanks,
Jimmy.

I believe that it certainly does depend on the situation. I can't believe there is one 100% right answer that applies equally across the entire country.

It appears that the 'break even' conclusion from McBride is really that the home would effectively cost you zero in present value dollars over the 10 year period. In other words you'd get out the amount of money you put in. Thats quite a lot better than renting a similar home and not getting any money back. Should easily put you $80k or more ahead over that 10 year period versus renting.

I own a rental worth about $150k right now. It rents for $1080. If you bought that house with 0% down total costs would be around $1020 all in for mortgage, insurance and taxes. Thats not countintg tax deductions. I can't see how such a property would be a loss long term if you bought it. Its cheaper to buy than rent it. And it will go up in value long term while at the same time rents will just go up every year.

DMFF, are you trying to say you think there might be some sort of PF blogger conspiracy to trick people into renting homes so that someone can profit off buying homes?

I agree with J.
I don't consider our home as an investment at all. Quite frankly if it was worth $1 nothing in our life would actually change. We both expect to be carried out of our home in a plastic bag when the time comes.

What is crucially important to us is our income during retirement but we have sufficient investments that generate far more than the income we need as well as having pensions and SS.

What I dislike about a great many individual rental homes is that the pride of ownership is severely lacking and they do little to enhance their neighborhood. On the other hand neighborhoods where almost every home is lived in by its owner show a great deal of pride of ownership with attractive landscaping and no obvious deferred maintenance. Speaking personally I would prefer to see rentals that were all professionally managed as is the case with large apartment buildings, condo, and town home developments.

I've "rented and invested the difference" for years ..knowing I'd move (military and my financial planner career) several times and often. It paid off. Even my Dad who owned a $16,500 house in 1959 that I sold for $137,500 in 2001, not inclusive of mainentance, roofs, siding, windows, taxes, etc., etc., made only about 3%~ in a higher inflation/return environment. The days like Old Limey speak of are probably over. It is a good time to buy NOW but, will you stay long enough for appreciation to happen? It won't overnite! I'm even $100K~ down on a 2008 home that was built w/ "sale prices" that were reduced twice prior. After a new home is 10 years old the maintenance piles up. Buy beacuse of stability and pride NOT as an investment. Rent because of convenience, cash flow and uncertainty. Usually the articles that predict things such as this (Dow 20,000, rent now, etc.,) are after the bubbles and a good signal to do the opposite they say son after publishing! LoL

>"100 percent of the time it was better to rent, rather than own."

It seems to me they really didn't try very hard to find counter examples- or they were not comparing apples to apples. There are a lot of ways to tweak the numbers.

Just for fun I decided to check out how much a comparable rental to my home would be. I found that The lowest listings in the area of a 3 br 2 1/2 bath home were a few hundred more per month than my current monthly payment which includes the property taxes, insurance, etc.

Let's assume the cost difference all goes to maintenance and covering closing costs. I still get the principle payments which amounts to about $450/month.

That isn't anything to sneeze at... Unless I wanted to squeeze my family into a small studio apartment I can't possibly reduce my monthly expenses by renting.
The one advantage for renting is that I could have invested my down payment.

My down payment is currently earning a 4% rate of return that is both risk free and tax free by reducing my monthly payments. I might be able to get 8% from the market but that is by no means guaranteed, and the last decade has been really bad for the market. If you do an apples to apples comparison you should look at CDs- which are returning only about 1% before taxes! So there is no significant gain there.

-Rick Francis

jim: No, its not actually necessary that they are actively "conspiring". Many of the bloggers (or their bosses) invest in real estate and the idea that renting is better than buying is something that even many non-blogger real estate investors would try to convince you of.

DMFF --

Just for the record, I don't invest in real estate, I own a home, and I'm one guy -- not part of a bigger blog group.

I can only imagine DMFF is still feeling burned by the revelation that some once-esteemed PF blogs, such as Get Rich Slowly, have really been secretly bankrolled by a corporate entity.

Of course, if FMF *has* been secretly bought out, he wouldn't be legally permitted to admit it. ;)

MonkeyMonk --

Ha! If I had been secretly bought out, you all would be reading a lot of "my retirement life in the Caribbean" stories. ;-)

It's getting very interesting here. Assuming same income for both owner and renter, at the end, the owner has $395,404 in hand, what would it be in renter's hand? I am sure someone smart can show us and explain why, isn't it?

Jun --

The $395,404 isn't in the renter's hand because the renter gave it to the owner of the house the renter is renting.

The reason the "renting is better than buying" advice is wrong and always will be is that the landlords have the same "problem" as the owner-occupants. If it was really a problem there wouldn't be any landlords to rent from because no one would want to own houses, whether to live in them or rent them out.

In other words, "rent = costs + profit", and costs includes opportunity costs (e.g. the risk free rate of return).

The only way to lose as a landlord is to pay WAY too much for the property (compared to what other people are paying for similar property at the time), which you shouldn't do anyway.

FMF --

You may not be part of any larger group, but you aren't the source of this bad advice either.

@DMFF,

Recall that I wrote a comment saying this article was wrong. However your statement that the only way to lose as a landlord is to pay WAY too much for the property compared to what other people are paying for a similar property at the time) is wrong.

We only have to go back to 2004-2007 to see this. People who bought in that time window all lost and investors were not paying anymore than anyone else. Everyone was paying too much but that is what the market price was. I talked to numerous real estate investors I know during that time and tried to get them to explain to me how it made sense to buy these properties as investments. For starters, rents were falling because people were leaving apartments to buy no money down houses. As a result of this and skyrocketing prices, almost all newly purchased properties for landlords were drastically cash flow negative. The belief was that rapid appreciation would make up for the negative cash flow. Instead rapid depreciation exacerbated the negative cash flow.

There are times when the price of a house is simply way too high and when that is true the landlords who didn't buy in at a much cheaper time are losing money. There are times when the rent is cheaper than the mortgage payment + expenses.

I agree that this is not usually the case and should not persist for long (although last time it persisted for close to half a decade) but it does happen. It is not true that the investors always win. Sometimes the market moves against the investor, and investors can be just as stupid as anyone else, sometimes stupider.

Apex --

Those people buying properties in 2004-2007 lost for exactly the reason I stated. That is the nature of a bubble. Someone has to be offering much more than the other buyers, otherwise it wouldn't be a bubble, it would just be growth.

So they took on enough debt that they couldn't make the monthly payments once rents started falling because renters started buying too. If they had been able to make those payments they would still own the properties and would be making money now that those former renters who bought and then lost their houses are returning to renting and rents are rising again.

There are plenty of examples of people who bought during that time and didn't lose their rental properties. Its fine to buy during a bubble, if you can manage to buy without feeding the bubble.

@DMFF

I think you misunderstand a bubble.

Bubble's don't exist because SOMEONE is offering much more than everyone else. That's frankly quite preposterous. They exist because everyone who is buying is offering much more than they are worth. Are you suggesting there were people buying properties of like kind for far less than others were? People who lost properties in that bubble did not do so for the reasons you stated. They did not pay much more than others. They paid what others were paying but that price was too high.

This is related to the same argument I have with people about how real estate is all about getting a great deal. No it isn't. I don't know what country these people think we live in but we have a free market here. The price you pay is the market price. There can be reasons why you might find a rare deal but generally speaking, you pay the market price which is a price very close to what everyone else is paying.

People who bought during that time and didn't lose their properties did so by purchasing with cash or with large amounts of money down so that they were not cash flow negative. Or perhaps they bought a small apartment type complex that was not in the same market as the single family housing market which cannot be compared to the bubble at all because it's an entirely different type of property. But if they bought a single family house they paid what everyone else paid and regardless of how much they put down to get it to cash flow, that still doesn't make it a good investment. It is still to this day worth less than the purchase price they paid (with some rare exceptions, as the entire real estate market is not all the same). And it was the case that renting was a much better deal than buying during that time.

The question at hand is not resolved by determining if someone lost their property or not. During a bubble everyone is feeding the bubble. If you are buying in that market and buying a property typical of what is selling then you are one of the millions who are setting the price that determines the market. The bubble is the market.

Before you make the decision of Rent vs Buy please consult this handy calculator from the New York Times. It was an eye opener for me back in 2007 when I was planning to buy a Condo for $180K in Houston. I decided not to buy and kept renting and it has been the best financial decision ever. That same Condo is now selling for $130K.

Even if the property did not depreciate a cent the calculator told me not to buy the place unless I was sure I'll stay for more than 6 years, this was the break-even time.

@Apex: The break-even time is the time it takes for the buy option to break-even with the rent option, it's foolish to think that there will ever be a break-even time for cero since this would mean you could live in a house for a number of years for free.

http://www.nytimes.com/interactive/business/buy-rent-calculator.html?_r=1

I too think the article is wrong in general and I'm a real estate investor and a PF blogger.

There are situations where renting makes more sense and situations where buying is better.

I don't think these articles are coming from real estate investors trying to push anything on anyone.

I think these articles are a reaction to people who saw the real estate bubble burst and are now just harboring negative perception towards the housing market due to short term outlook.

DMFF, you're still not correct. If I'd bought my rental properties 7 years ago for 3 times the current price (and at higher interest rates), even if I still had them today and had managed to refinance to lower interest rates, I'd still be losing money with today's rental rates. (Note - I'd likely have been losing money 7 years ago at those rental rates too). My point is, you're not "automatically making money" because rents are coming in. Rents have to exceed expenses, and if expenses are based on a much higher purchase price than the current value of the property, you're not likely to have today's rent exceed that amount.

You seem to be suggesting that investors 7 years ago shouldn't have "bought into the bubble" and instead should have simply paid much lower prices than everyone else did at the time.

I think FMF's 3rd bullet point completely nailed it. Hoome ownership is a kind of forced savings. It puts people in more of a savings mindset than they would be otherwise (at least some people).

The main thing is to keep your total housing costs low as a % of your gross income. To me that means 25% of gross or less on total housing costs (including repairs). it's actually easier to budget if you're a renter...but the problem with renters is most don't have a savings mindset, so as FMF said, most renters blow any extra income they have instead of putting it in 401ks, IRAs or other savings.

This study is garbage. Even Warren Buffett recently said if he could buy up thousands of foreclosures and manage them as rentals that this would be the smartest financial move one could make right now.

I know because I am a landlord. The first flaw I see is looking at $200,000 homes. I have one of those and it is the only rental property I own that I lose money on. The money is made on modest or lower income properties, where the rent/cost ratios are better.

Example: I bought a 2/1.5 townhouse in September for $22,500, spent $4,000 on improvements and had it rented 6 weeks after purchasing it. The rent is $695 per month. I pay $750 per year property taxes, $600 on insurance, and budget 10% of the rent towards repairs and maintenance. I acquired the property using 0% credit card advance offers, paying a 3% fee to access the money. The 0% rate is good for 18 months.

I spend a little over $2,000/year on this property. Assuming the property is occupied 85% of the time, I bring in about $7,000/year, or $5,000 net of expenses.

Cost: $26,500
Return: $5,000/year
Yield: 18.9%

How many of your stocks consistently and conservatively yield 18.9%? Note that I usually raise the rent each year, so my cash flow at a minimum keeps up with inflation.

Just to be fair, you will notice I did not include financing on the acquisition since I used a 0% cash advance and intend to pay this off in 18 months. Even if the cost of this cash is 10% per year ($2,650), I would still net $2,350, a yield of 8.9%.

Any way you slice it, the math works for me.

I haven't read through all the comments yet, so I don't' know if this has been mentioned yet, but I think the numbers will need to be re-crunched. So many people are not buying houses right now, that rent is going sky-high.

When we had to move in 2009 we were unable to sell our condo because the value had gone down so much on it. We ended up renting it out, and it sat for 4 months empty until we could find a renter. We eventually found someone who was great - for $1000/month. They will be out at the end of April after 2 1/2 years. I relisted it, and after only 3 weekends of showing it, I already have a 2-year signed lease for $1200/month, plus I had people interested in paying 1250/month but for a shorter lease.

If people think it is cheaper to rent, there will be more people renting. Supply and demand - rents will go up.

Let me try one more time. Here is my early posting
-- "It's getting very interesting here. Assuming same income for both owner and renter, at the end, the owner has $395,404 in hand, what would it be in renter's hand?"
-- If you can give me a clear answer of what is in renter's hand and how your get the number, then the problem is solved. We all know which is better off regardless all the theoretical debate.

I would say "it depends". If you're going to stay in the area less than 5 years, or don't have an emergency fund, or you're not saving for retirement, then don't buy a house. Also, and I believe this is a biggie, don't buy more house then what you can afford and what you NEED (not WANT--more people have gotten into trouble because of trying to maintain the cost of a bloated house). If you stay for a long time, chances are better of someday having a bought-and-paid-for place to live. I'm retiring in less than two years and my condo will be paid for in two months. HOORAY!!

@Tony,

Sorry, but the numbers in question in this article do not assume a break even in comparison to renting. I agree it should. That's the whole point. Buying a 200K house and needing to sell it for almost 400K 10 years later in order to break even with a rental option is preposterous. That is a plan to be able to live for free for 10 years which as you say is ridiculous but that is the numbers this article uses.

I think its safe to say the 5 year rule is probably one of the best pieces of advice to follow given any situation.

Hate to break it to you but even if you lose 50% of investment when selling your home, it's better than losing 100% of your rent every month.

Stupid article is stupid...

@Ash,

While I agree that the article is wrong your form of argument is not correct.

If you buy a million dollar home and lose half of it over 5 years plus all your mortgage payments, insurance, etc, that is far worse than losing 100% of even a $5,000 per month rent payment.

You seem to be coming from the standpoint that many have argued from in the past which is that it's always better to buy than to rent. It often is better to buy than to rent but it is not always true. And if you own for a short window it is almost always not better to buy. The question does require the consideration to be a little more carefully thought out than the simple argument you have put forth. It sounds clever but it's unfortunately not accurate.

Setting aside all of the financial analysis, as it's somewhat "noise" in the big scheme of things, I believe there is one non-financial aspect that is the tie-breaker for me. Living in a paid for house adds a tremendous amount of (at least mental) security and peace of mind. With this paid off home, your options for retirement, career path, etc, go way up. I guess you could get to that point with a rent that is well under your means, but the security of living in your own paid for asset cannot be beat. At least that's my take.

Setting aside all of the financial analysis, as it's somewhat "noise" in the big scheme of things, I believe there is one non-financial aspect that is the tie-breaker for me. Living in a paid for house adds a tremendous amount of (at least mental) security and peace of mind. With this paid off home, your options for retirement, career path, etc, go way up. I guess you could get to that point with a rent that is well under your means, but the security of living in your own paid for asset cannot be beat. At least that's my take.

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