Recently, a few colleagues and I were discussing the rent vs buy decision on home ownership. Prompted by the recent sale of her house, one colleague wondered what she should do with the equity proceeds. She was now living in a new city and state, and midway through the lease agreement on temporary housing while the old home was going to close. Ultimately, though, the conversation boiled down to addressing the angst many of us feel about not making the right financial decisions.
To be clear, none of us at HelloWallet has a real estate license or are otherwise experts in commercial or residential real estate. But that did not stop us – nor would it, I suspect, stop most people – from rendering an opinion. However, HelloWallet does have a culture of objective data sourcing, layered with a healthy respect for behavioral psychology, and an appreciation for the self-serving interests of other industries. So while this conversation began with the real estate industry, rest assured that we are equal opportunity agitators.
I answered first with the following explanation: the long-term returns from the real estate market are roughly half the returns of the stock market. If one excludes the noise from the last decade – which I encourage, given it was an artificial bubble predicated on the greater fool theory of loan securitization – then real estate returns are even less than half of the stock market over the long term.
Another principle consideration is most people can rent for a discount to the mortgage of an equivalent home or apartment. Therefore, the economic comparison must factor in what the renter could otherwise do with the excess cash they would be saving. In this case, the best long-term alternative for those savings would be some sort of market investment.
I will ignore here the much more detailed, true cost of ownership analysis that must take into account new roofs, real estate taxes, insurance, remodeling and all the upgrades you will be enticed to undergo because it is your home (hurray!) and not simply a rental. These additional costs can potentially make home ownership much more expensive than renting. However, every market is different, so local pricing inversions do occur. Additionally, new online platforms like Trulia and Zillow chip away at transaction costs for potential buyers. Be sure the standard 6% commission rate is under a lot of pressure.
On the flip side, being a renter places you at the whim of rent escalation, more frequent moves (which do cost money), and limitations on what you can do with the property (you want to reface the kitchen cabinets – tough luck). Furthermore, renters often have an ongoing and more frequent relationship with someone not nearly as professional as a mortgage loan officer.
Perhaps more important to the decision process is the fact that our society is engineered to promote home ownership. It is the American dream, so say all the advertisements from the National Association of Realtors. It is that dream which makes you picture years of backyard barbeques in the same home, where friends and family create lifelong memories in a familiar environment. Even the US government is in on the action, subsidizing home ownership through the tax code by allowing mortgage interest deduction. Departing from this conventional wisdom is no trivial matter and fraught with emotional uncertainty.
When I (finally) finished another colleague offered up the following view: buy a home when you decide it is the place you want to live for a long period of time, or perhaps even forever. When you know you won’t trade up in a few years, or otherwise feel as though buyer’s remorse is right around the corner from the settlement agent, then you know you have found the right home. While this is not an economic decision, with the appropriate criteria it can absolutely be the right decision.
As much as I like math, and am quite certain of the quantitative foundations of my answer, I like my colleague’s better than my own. If it will be a house, rent it. If it will be a home, buy it.