Renting Makes You Richer

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Last updated on June 14, 2018 Views: 547 Comments: 36

Over the weekend, Moom left a comment on 7 Ways to Kill Your Net Worth after observing a number of mainstream media articles touting the idea that real estate — your own home — is not a good investment.

Interesting how now that the housing market is stagnating or going down in many regions there are all these articles saying “don’t buy too much house” 🙂

Personally, I remember seeing this common advice when the market was booming. Although when exuberance was the general attitude towards the investment worthiness of real estate (including your own home), I also remember seeing more of the “buy as much house as humanly possible, it’s guaranteed” advice.

As if on cue, I found another article on the intelligence of renting rather than buying. First, a basic comparison:

Shares return 7% a year after inflation because that’s how fast companies tend to increase their profits. Houses have their own version of profits: rents. Tenant-occupied houses generate actual rents, while owner-occupied houses generate ones that are implied but no less real: the rents their owners don’t have to pay each year.

House prices and rents have been closely linked throughout history, with both increasing at the rate of inflation, or about 3% a year since 1900. A house, after all, is an ordinary good. It can’t think up ways to drive profits like a company’s managers can. Absent artificial boosts to demand, house prices will increase over long periods at the rate of inflation, for a real return of zero.

So on average, after inflation, shares of company stocks have returned 7%, while real estate has returned nothing over the past century plus. Real estate pundits get around this by ignoring everything up to World War II.

The average pundit, planner, lender or broker making the case for ownership doesn’t look at returns since 1890. Sometimes they reduce the matter to maxims about “building equity” and “paying yourself” instead of “throwing money down the drain.” If they do look at returns, they focus on recent ones. Those tell a different story.

Between World War II and 2000, house prices beat inflation by about 2 percentage points a year. (Stocks during that time beat inflation by their usual 7 percentage points a year.) Since 2000, houses have outpaced inflation by 6 percentage points a year. (Stocks have merely matched inflation.)

So what caused these post-war and 21st century surges?

  • The government subsidized housing by relaxing borrowing standards in 1934, creating the ability to make down payments of “only” 20% and to stretch a loan for 30 years.
  • When the stock market tanked in 2000, the government lowered interest rates very quickly, which caused frenzied house buying to take advantage of the low rates.

The author, Jack Hough, suggests that in order to keep up the housing returns of the past 20 years for the next 20, the government would need to relax housing standards even further. With the increase in foreclosures, that’s unlikely to happen. The author also believes that house prices probably won’t drop because owners aren’t likely to sell in down markets (like they do with stocks) and prefer to hold it out.

Here is the calculation that shows how renting and investing the difference you would normally pay for maintenance expenses pays off more than buying a house and paying for the incidental costs over 30 years ($700,000 on a $300,000 house according to the Wall Street Journal):

If you have $300,000 and a choice between spending it on a house or shares, you’ll pay $6,000 a year in incidentals if you buy the house or about $15,000 a year ($1,250 a month) in rent if you buy the shares. But the shares will return $21,000 a year after inflation while the house will return zero. (My numbers work out even better than these. I pay a smidgen less than $1,250 a month for rent, while house prices in my neighborhood are far higher than $300,000.)

In the second page of the article, the SmartMoney author refutes anticipated arguments, including:

  • Homebuyers get tax breaks. (The tax breaks aren’t that good, investors get tax breaks, too, and most homeowners don’t or can’t take advantage of these tax breaks.)
  • You seem to knock government housing subsidies, but they’ve helped many Americans afford homes. (The author says the subsidized also helped to raise prices, making housing not affordable for many in the middle class.)
  • Houses are bigger than apartments. (You can find single-family houses to rent, not just traditional garden or tower apartments.)
  • Are you saying I should sell my big house and rent an apartment instead? (No, the strong demand for housing keeps renting cheap.)
  • Renting is for poor people. (It’s also for rich people. “Poor people rent modest apartments for lack of choice. Middle-income people buy houses. High-income people, presumably with a dose of financial savvy, often rent nice apartments instead of buying.”)
  • You say houses return zero. But I’ve made a fortune on my house in recent years. (Recent performance is due to external forces that won’t be in play in the future and returns will revert to the mean — in line with inflation.)
  • So you’re never going to buy a house? What about raising a family? (The author is 34 years old and engaged and hopes to rent for 10 more years. He thinks he’ll move into a bigger apartment when necessary.)

It’s been ingrained in our culture by the media that the “American Dream” is to own a piece of land and a house upon that property, and we’ve been led to believe it is a failsafe investment. I haven’t decided on my position in this debate, but I’m probably going to rent for at least another year to give me a chance to make decisions about where and when I want to “settle down” into a long-term relationship with a piece of property.

Article comments

Luke Landes says:

Andrew: I couldn’t agree more; life and finances aren’t simple and rules of thumb of any sort cause more problems than they solve.

Anonymous says:

They key isn’t paying off a home or renting… the key is making sure that whatever assets you are generating on a monthly income are at their most “available” level as possible. For many, that can be done in short order with a mortgage. Others, due to life-chance uncertainty such as career change, are much better suited to rent an apartment or a single family home.

There are many things that can be reduced to “simple maxims” to live by. Rent vs Buy isn’t one of them due to the extreme number of variables including non-quantitative personal opinion that enter the equation.

Anonymous says:

I have to agree with Dave. Pay off your house. Then you have whatever it appreciates in value + a huge chunk of money each month to invest that would otherwise be going into rent.

Anonymous says:

Though house payments don’t go up, property taxes frequently do. If you own a condo or a property with homeowner association dues, they will increase, and sometimes owners are hit with a special assessment when there’s something like termites, plumbing problems or lawsuits. So being a property owner does not make you immune from rising costs.

I plan on using a fifteen year mortgage when we eventually buy again, but for now we are renting and enjoying adding to our savings every month and going on weekend trips and letting our landlords stay here and fix the leak above the bathroom window.

Anonymous says:

Dave, that’s only true if you never invest your money. For example, I can make a 20% down payment or I can take that money and invest it in the stock market.

Yes, I could live in my own house rent free in 30 years. Or I could rent a house but have that rent be paid for by interest from my investment 30 years ago. Either one makes financial sense. Just need to run the numbers.

Anonymous says:

This is a question my fiance and I are now struggling with. We’ve done the math and in, in our area, houses are slightly behind stocks if you look at them as a pure investment. However, there is something to be said for owning your own house. You get to make your own decisions on things like appliances, wood floors vs. carpeting and so on. Also, rental units will typically not be as nicely decorated as something you do on your own. Finally, rental units come with rules on things like pets or # of cars. So it’s not just down to a pure money comparison.

All that said, we’re still trying to figure it out. Right now, we’re probably going to rent for a while longer while we look around, see what’s available and decide on what we really want to do.

Anonymous says:

Never buy? Pay rent for your entire life. Buy your home? Pay it off in 15 or 30 years, and then live free of rent and mortgage payments for the REST OF YOUR LIFE, as do any heirs to whom you pass the house (estate taxes and property taxes being separate issues).

And tax breaks help not only with buying, but also selling: keeping most or all of your capital gains on your primary residence.

As with most things in life, renting can make sense for short-term needs or when lifestyle changes happen or career uncertainty exists. But long term? Buying once instead of paying for it over and over seems to make more sense.

But the true $$$ criteria is after-tax discounted cash-flow qualified by individual tolerance for the risks inherent in both renting and buying. The after-tax discounted cash-flow is what real-estate moguls (not speculative house-flippers gambling on a bubble) use to evaluate purchase of a property they intend to hold onto.

Anonymous says:

There’s a lot of talk about that “American Dream.” I wonder if the people getting their homes foreclosed feel that it’s a little more like the “American Nightmare.”

Anonymous says:

There’s some truth in the analysis — but the counterpoints are good as well. However, both sides look to be referring to a house purchased on a 30-year mortgage.

First, a 15-year mortgage will likely run a quarter point lower than a thirty. Yes, the payments are a little higher per month (around 25-30%), but you pay under HALF as much in total interests payments.

Example: On a 6.00% 15-year mortgage for $250K you pay a total interest charge of $129,736. Pick a 30-year for the same amount and you’ll pay 6.25% and a total of $304,148 over the life of the loan. OUCH!

The best option in my opinion is to get a 15-year mortgage rather than renting. Of course, it is also very important that you stay in the house since the early years are still mostly interest. If you are going to move every 3 years — RENT: you aren’t accumulating any real equity plus you’re paying the costs of buying and selling and maintenance. If you are staying put, however, you’ll come out ahead if you buy no more house than you can afford on a 15-year mortgage. 30-year mortgages are a terrible waste of your financial resources.

Anonymous says:

[…] Consumerism Commentary takes up the discussion on how renting makes you richer. […]

Anonymous says:

Keep in mind, however, that rent is an ever-increasing thing, whereas house payments (aside from taxes and insurance) are locked in. Don’t you therefore get ahead of the curve over time when you buy a home (assuming a fixed rate mortgage and no re-financing to reset the clock)?

Anonymous says:

I always make a ton of money off my homes. I say “homes” because I build my own house as a general contractor and sell it after two years.