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Renting vs buying, and how to think about the choice

The question of whether to rent or buy a home is one of the most common that financial planners help their clients grapple with. For good reason: it is one that can have rippling implications along many aspects of your financial, and non-financial, life. So how do you begin to know what to do?

First, I’ll say off the bat that there isn’t one right answer. You’ve probably heard people knock renting as throwing money away, and buying as a bad investment. Neither are really true, of course.

We all have to live somewhere, and we probably have to pay for it. While some advocates for renting like the “debt-free” aspect of the lifestyle, I would respectfully argue that renting is also debt. It doesn’t exist as a liability in your net worth the way a mortgage does, but if you stop paying your rent, you….will be minus one roof over your head just the same. So I prefer to think of this as simply your monthly housing cost, which can take many forms: rent, mortgage, maintenance, etc. One can just as easily overextend themselves with a too-costly rental as with a mortgage that’s beyond their means. The end result is the same - it will take away from the other goals. So, consider what other obligations you have for your dollars - retirement savings, education funding, other debt to pay down, your current lifestyle you’d like to maintain - and determine a general dollar range of monthly housing expenses you can comfortably support.

The biggest tipping point for me to recommend buying over renting for my clients, if buying is something that would otherwise suit their lifestyle, is the length of time they are planning to stay in the home. If it’s likely to be less than 5 or so years, it makes more sense to rent. A lot of friction costs can be avoided and down payment dollars directed to other investment vehicles. On the other hand, if you plan to stay somewhere long-term, then locking in a portion of your housing cost begins to make some sense.

Is a house is a good investment? You can’t compare it to a market portfolio, because, as we all know, you have to give the dollars a job. The job of the housing dollars is to provide housing. You might end up doing very well with a real estate asset, even taking into account transaction costs and maintenance and everything else that goes with it. But when I think of real estate as an investment, I think of it as an investment in a community; this is different than buying a stock or bond or mutual fund. Don’t buy a home somewhere if you’re expecting to simply cash out in a few years and leave.

Other important points to consider: how willing and able someone is to undertake routine maintenance on their own; whether the property is expected to produce income; the importance of career and lifestyle flexibility; and the desire to customize the living space.

There is a mathematical approach to this, too. It involves comparing two scenarios: using your savings for a down payment, getting a mortgage, and ensuring you have enough left over for maintenance and carrying costs, vs investing the savings, renting, and investing the difference in monthly outlay. The idea is based on two generally accepted assumptions: that a comparably-acceptable home is less expensive to rent than buy at the start, and that the principal and interest portion of a mortgage remain the same over time. Ceteris paribus, this is a helpful exercise to understand the difference in outcomes of the two, and to feel more comfortable making an informed lifestyle decision. Often this helps break the logjam of indecision. The problem is that there are enormous (really, quite big) assumptions being made:

  • Primarily, that if one chooses the “rent-and-invest-the-difference” path, that the difference actually gets invested on a regular, timely basis, regardless of market conditions. Given what we know about human behavior, this can be a very big ask. Life gets in the way! One reason real estate does end up being such an important asset in a family’s net worth is precisely because that mortgage gets paid month in, month out, and the equity grows.

  • That eventually, the mortgage, if it’s fixed, takes up a smaller and smaller portion of your monthly overall cash outlay. Careers take various paths and breaks.

  • Similarly, that rent (or property taxes, or insurance costs) will only increase by a predictable amount. Shifting demographic trends (and things like global pandemics) will have long-ranging effects

  • That a market portfolio of securities will outperform real estate, but of course, properties in many high-demand areas have seen equity-like returns

  • That the tax benefits of owning - namely, the ability to deduct mortgage interest and property taxes - will continue. Tax law is written in pencil. Tax law is written in pencil. TAX LAW IS WRITTEN IN PENCIL. Don’t make a home buying decision because of the tax benefits. And don’t take out a bigger mortgage than you can afford because of the deduction.

Still, an analysis like that can be a great starting point for deeper exploration, and can illustrate how some very strongly-held perceptions about owning real estate - both positive and negative - hold up in a more or less realistic scenario. When considering the scenarios, try to add a “worst-case” illustration in which your inputs change significantly to see a broader range of outcomes.


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