Buy or Rent?

To buy, or not to buy, that is the question.

A home can be both an asset and a liability. Over time, real estate is a solid investment, but in the short-term it can cause financial heartache.

My parents have lived in their home for more than 45 years and they have significant equity. They’ve used their home throughout the years as a source of funds to pay for weddings and college educations. However, they’ve also had to replace roofs, windows, garage doors, air conditioning units, etc.

It takes time to build equity in your home, so if you plan to stay in your city for ten years or more, then buy a home. According to Freddie Mac, the average length of homeownership at the end of 2017 was ten years.[1]

My first reaction is that owning a home trumps renting. A home builds equity through monthly mortgage payments. The old argument is that it’s a forced savings vehicle. In addition, interest payments and property taxes are deductible to a point.  

The Case-Shiller Home Price Composite 20 Index has averaged an annual return of 4.1% since January 2000 despite a 34% drop in housing prices during the great recession.[2] The S&P 500 Index, by comparison, averaged 5.3% for the same period.[3]

Aside from financial benefits, there are several emotional reasons to own a home. A home is a place to hang your hat, a refuge for children to return to during college breaks, and a storehouse for generational gatherings. And, regardless of economic conditions, it’s your home.

We lived in Connecticut for a few years and our home had a finished basement covering about three quarters of the area. The remainder of the basement was storage for our tools, kayaks, bikes, workbench, etc.  When my daughter was young, we painted some fall leaves on butcher paper.  In addition to the butcher paper, we also painted a portion of the floor. At first, I was upset but then I thought this is our house and we can do whatever we want. It also added a touch of character to the basement and when I saw the paint on the floor it was a nice reminder of the joy my daughter and I had that afternoon.  We also used our pantry to measure her height. Each new notch on the door frame represented growth for our family.

Owning a home does not guarantee nirvana as there’s always something that needs a tweak or twist and every few years a major expense pops up. Replacing windows, a roof, or an air conditioning unit is not cheap. Annual maintenance and upkeep can cost you about 1% of the value of your home. If your home is worth $500,000, expect to spend about $5,000 per year.[4] Depending on where you live you may have additional fees like HOA dues.

Renting makes sense if you’re on the move every few years. If you’re in the military or some other profession that requires you to relocate often, renting makes sense. Also, if you’re new to a city and you want to get the lay of the land, renting a home is better than buying - especially in a city that is experiencing rapid growth, like Austin. Renting will give you an opportunity to explore different neighborhoods and travel patterns. The average rent in Austin, New York and San Francisco is $1,518, $3,415, and $3,772, respectively.[5]

Saving money for a down payment is another reason to rent. If you don’t have enough money for a 20% down payment, then renting a cheaper home or apartment while you build up your cash reserve is a smart move. The median home price at the end of December was $253,600, so a 20% down payment is $50,720 – a big nut to cover for most people.[6]

I’ve found that people who rent to save money usually don’t. If you’re renting to save, then you should invest the difference. Establishing an automatic investment plan will help you be intentional about saving. It will also remove the temptation to spend the difference.

Affordability is another issue. Don’t buy a home you can’t afford. Your monthly mortgage payment should be less than 28% of your gross pay. If your gross income is $10,000, then your monthly payment should be $2,800 or less. A mortgage payment of $2,800 equates to a $372,000 mortgage for a 15-year loan and $569,000 for a 30-year loan.

A couple of downsides to renting is that your landlord can sell the land under your feet or raise your rent. Renting is forever and you never have an opportunity to build equity. I know renters will say they don’t have to pay property taxes, but taxes are deductible, and rent is not. Several cities will cap their property taxes at a certain rate or age as well. Packing and moving every couple of years is also a deterrent to renting.

Here’s a recap to help you with your decision to buy or rent your next home.

  • If you plan to live in your city for ten years or more, buy a home.
  • If you want to build equity, purchase a home.
  • If you move every few years, rent.
  • If you don’t have enough money for a down payment, rent.
  • If you want to be mobile and explore new cities, rent.
  • If you’re a homebody and don’t like to pack, purchase a home.

Be it ever so humble, there’s no place like home. ~ John Howard Payne

February 18, 2019

Bill Parrott is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

 

 

[2] YCharts. Case-Shiller Composite 20 Index, 1/1/2000 – 11/30/2018.

[3] Morningstar Office Hypothetical Tool, SPY ETF, 1/1/2000 – 11/30/2018.

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