On Sunday, I noticed yet another new article describing the benefits of renting over buying a house. I’ve been following these articles with interest as my lease is getting closer to its end date six weeks from now, and I’ve been thinking about what to do. In this article, Liz Pulliam Weston provides 3 reasons not to buy a home. Here’s what she thinks:
1. It’s not always a good investment. Neglecting abnormal returns from 2000 to 2005, real estate has appreciated only 1% over inflation since 1969. Also, home appreciation figures don’t take into account all the money people pour into their houses in the form of repair in upgrades, which I’ve mentioned quite a bit lately. “A home is primarily a place to live. Its value as an investment is secondary and certainly is no replacement for a well-diversified portfolio of stocks and bonds.”
2. Renting isn’t necessarily throwing your money away on rent. It’s funny, some of the people who tell me I’m throwing money away on rent are people with interest-only mortgages. They’re not building equity. Even if they were paying some principle, they’re still counting on appreciation to build equity, and that’s a risky proposition. Liz Pulliam Weston explains renting isn’t throwing away money, and it’s actually a better deal than certain mortgages. When you rent, you’re not responsible for maintenance, and you have the flexibility to move whenever you want. Although you may be penalized for breaking a lease, the hassle and expense is less than trying to sell your house quickly.
3. The tax deduction isn’t the benefit most people think. “Buying a house just for the mortgage break would be like giving somebody a buck just to get 35 cents or less in return.” The tax deduction argument doesn’t make mathematical sense. If you normally pay $100 for a Widget A, and someone gives you a coupon for $50 off Widget B, it sounds a good deal at first, until you realize that if you want Widget B which costs $100, you also have to pay $100 in extra costs. Even with the coupon, you’re paying more than if you had just chosen Widget A as you originally intended. The coupon (tax deduction) is nice, but you end up paying more anyway.
Before you jump into the home ownership pool, Liz suggests being able to agree to these statements:
* I plan to stay put for at least three years.
* I can swing all the costs involved.
* I want to be a homeowner.
Like I said, there seem to be a large number of articles in the media lately about the benefits of renting over buying a home. When it comes to the market, I tend to have a contrary viewpoint. This would explain why when the equity markets were flying high lately, I started allocating less to equities. It’s mini-market timing, but I’m comfortable with it. Once a frenzy over the benefits of renting is here, you can bet rents will go up and it will be much less of an advantage.
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A home is not an investment! You can use real estate as an investment, but I think it’s just wrong to think of the home you live in as an ‘investment’.
When you buy (mortgage) a home, it becomes yours. You can update it, tear down a wall, fix up the front lawn, paint the walls or change the light fixtures…and no one can tell you not to. Renters never have a ‘home’…it always belongs to someone else.
Tax deductions are nice, but lets remember that its not a tax deduction on the house, it’s a deduction on the interest you pay. The goal is to own your home, which means no deduction.
This is exactly what I’m trying to convince my wife.
I agree with all those points. Get ready for the inevitable onslaught of anecdotal “But I made 100% on my house in 4 years!” posts.
There are a lot of lucky people that got rich by buying AMZN stock too, but it’s important to realize that as with the stock market in the late 90s, housing just went through an extremely anomalous period. Returns from this period should not be expected to repeat.
The tax deduction argument really bugs me. I see otherwise intelligent people parrot this fallacy. Many of them itemize *only because of their mortgage*. In other words, they don’t get to deduct the full interest anyway. They only really get to deduct the portion of the interest that pushes them above the standard deduction.
Sound advice from Liz. Had I fully appreciated this, I might have bought a smaller house two years ago when I was in the market, and expose myself more to the stock market sooner.
Jonathan
I think the biggest tax break is that you can sell it tax-free. A consistent 1% over inflation with enough 5-to-1 leverage is not half bad, either.
We bought a house when we got married last year. We now own OUR home, my wife and I are very happy with the decision. In addition, we live in the midwest, the houses here are affordable.
Agree with the comments about a home not being a pure investment. Owning a home has intangible benefits that do not purely translate into monetary value.
If you’re interested in timing and contrarian views, then you should be reading Harry Dent Jr and his economic forecasts.
I think the article is pretty spot-on, especially her 3 suggestions. The really critical one in terms of how much financial sense buying a house makes is the first one: how long you plan to stay.
Closing costs, taxes, moving expenses and the high percentage of your payments that is devoted to interest in the early years devours most if not all of the financial benefits of owning for the first few years. 3 years is the barest minimum. 5 is better. Longer is great.
Also, if you choose to buy, pick the appropriate mortgage for your needs. For the overwhelming majority of finance-minded people I think the 15-year fixed is the ONLY mortgage to choose (I have some mortgage analysis up on my site if you’re interested). If you have to get a 30-year mortgage to make your payments you are trying to buy more house than you can afford — look elsewhere. 30-year mortgages are financially deadly.
Good luck making your choice!
Never underestimate how important leverage is when considering buying a home. If there isn’t a very large difference in your area between the monthly rent and a monthly mortgage payment, the small(ish) additional cost each month buy you into a very large investment. Even if appreciation only equaled inflation you can make money at a significant rate early in the mortgage.
If renting is substantially cheaper then this may not apply. You’re paying a lot extra for the investment and your leverage isn’t so great anymore. Where I live there is very little cost difference between rent and mortgage payments . . . so consequently it’s a no-brainer to buy a home, even if it’s relatively short term (2 years at least to avoid taxes at the sale).
Let’s not forget about the 6% commission you’ll pay if you use a broker to sell your house. With a short time horizon of three years, you could end up with a significant loss after inflation.
Ironically, the housing bubble has made it more attractive than ever to rent. More people who were marginally able to buy a home did so and stopped renting. That keeps the price of rents low.
With a 6% realtor commission and 5% appreciation over 3 years, you’re still up about 8.8% (1.05^3 * 0.94=1.088) in the value of the house minus the cost to sell. That’s about 2.8% annualized and that gain is on the value of the house, not the amount you have invested.
These numbers will certainly vary based on all kinds of unknowns. I don’t want you to think I’m arguing that house jumping is extremely profitable– only that in a market that goes up, even barely above inflation, leverage makes a big difference in the financial outcome. It cannot be ignored.
It’s just a pet peeve of mine when I see the argument that buying isn’t so great because residential real estate only appreciates 1-2% over inflation. It completely ignores a HUGE part of the equation.
Buy when you feel right about it. Don’t get talked into it one way another. I think the points the article makes are good. Being able to answer yes those questions is critical.
Investing in real estate is whole another issue than buying a home.
There are several reason to not purchase a House. It is call quality of life.
It is the same reason for selling your house and consolidating your debts … The #1 cause of death and illness in the G-7 Countries is Stress … and too much debt load spells stress and purchasing a house is a major stress factor.
It changes your life and reduces your Cash Flow .. ie the amount of liquid funds you have in your pocket … is a house worth the stress …
Just because interest-only mortgages aren’t any better than renting (as far as building equity) doesn’t mean that renting isn’t throwing away money.
If you’re buying something to live in as an investment, then it’s not necessarily a good investment. But if you’re buying something to live in to have somewhere that is yours to live in, then it makes sense … unless you move frequently, of course.
None of these articles take into account anything subjective like decortaing and renovating and the like. I agree with Chris on those points.
They also don’t consider that while you’re not responsible to pay for maintenance in renting, you’re also at the mercy of your landlord to get it done. I’ve had more than one landlord that didn’t get things done or did them half-assed to save money.
I’d rather live in my own “investment” than someone else’s.
* I plan to stay put for at least three years.
* I can swing all the costs involved.
* I want to be a homeowner.
I think those three points summarize the commitment best. If you aren’t ready, than don’t do it!
The more I read online about people and real estate the less I want to do it ;) Snork Maiden is even less enthusiastic than I am. Owning a house would be a psychological negative for me. I can’t see the financial advantages.
Great post Flexo. I think another thing to consider in relation to reason #1, is how long could it take to sell your home. For example, if your area has months of inventory available, you might have to put it on the market well before you actually want to move, or you might end up needing to deal with it after you’ve already left the area. I’ve known people who’ve worried about selling so they put their house on the market, it sold fast, and then they had to rent for their last few months in town. It was a bit of a hassle, plus the cost of the intermediate move.
Great post, I recently decided to rent instead of buy, and I feel a lot more justified in my decision now.
Don’t forget that owning and buiding equity and writing your taxes for 7 years thus lowering your taxable income is a very effective wealth building strategy.