The Joy of Renting
As one of the few who was fortunately enough to sell my house prior to the real estate crash, I want to share some of the rationale that led to my decision and highlight some of the benefits I've been able to enjoy as a renter.
1. Lower Costs. The all-in costs of renting can be much cheaper than buying the same house if you account for the costs of the mortgage (principal plus interest, less any tax benefits from deducting mortgage interest), property taxes, insurance, association fees, and ongoing maintenance costs, not to mention the lost investment income/interest from the initial down payment. In contrast, the cost to rent is simply a flat amount over the course of the lease and even some of the basic maintenance and association fees are generally included. The "start-up costs" to rent are also much less than a down payment, typically around the equivalent of a one month rent. Just based on a small sample of renters I know in the San Francisco Bay Area, the savings can be quite significant, with renters typically paying 50-65% of the cost to own the same home. While this will certainly vary by location, the savings are nonetheless real and can translate into money in your pocket or a better quality of life if you choose to instead rent a better/larger home for the same cost to own! If you are interested in more analysis and information on this topic, I suggest Patrick.net as an excellent resource.
2. Asset Protection in a Down Market. Particularly in a down market like the past few years, renting provides a natural hedge against any declines in the value of your home by eliminating your exposure to this asset class. While this may not matter for long term holders, people who have shorter holding periods or prospective buyers could benefit from effectively "timing the market" by renting.
Of course, the flip side of this is the risk of potentially losing out on any profits if the real estate market is appreciating. However, I believe that this risk is largely mitigated by two factors. First, because real estate prices typically do not adjust over night like the stock market (except for highly speculative markets in emerging countries), there should generally be sufficient time for a renter to enter/re-enter the market as prices are rising without losing out on too much of the asset appreciation, if at all. This, of course assumes that you are managing your finances in such as way as to provide yourself with the flexibility to buy with short lead time. The second mitigating factor is that with your capital not tied up in real estate while you are renting, you could could also potentially profit from allocations in other asset classes.
Let me illustrate what I mean with a hypothetical example based on the market conditions that we've experienced over the last few years:
- You choose to rent instead of purchase a $200,000 home. If you had bought the home, you would have put $40,000 down (20%) and taken on a $160,000 mortgage
- The market declines over the next 3 years and the house is now worth $100,000. You would have lost your down payment and your mortgage would exceed the value of your home.
- Meanwhile, you've put the $40,000 down payment in a money market account yielding 2%, so now it's worth $42,448 after 3 years.
- The housing market rebounds nicely over the next 2 years (though not to former prices) and the house is now back to $144,000 (+20%/yr), so even if you had bought and held, you would still be equity-negative on the investment. But as a renter your original down payment is protected (now $44,162 @ 2%) and you've actually earned a return which is not bad in a down market, and it's still not too late to get back into the market and be in a stronger position to benefit from the rebound (now with 30% down and less debt).
Of course, hindsight is 20/20 and you will only have the opportunity to optimize against this scenario by renting if the real estate market should "double-dip". And in an rapidly appreciating market, this may not improve your investment returns. But the reality is that we are likely to see a fairly stagnant market for the next several years (e.g. the rebound scenario above is not likely to happen), so a good plan for asset protection could help you profitably time the real estate market, or at a minimum, reduce your losses should the market continue to decline.
3. Flexibility. Perhaps you've always wanted to live by the water, a golf course, or experience life in a more urban setting. Maybe you want to move to a new school district for your children but have reservations about the community. Or you and your spouse have different priorities when it comes to a home purchase and it's difficult to negotiate a compromise. In all of these cases, renting could provide you the flexibility to experiment and literally "try before you buy". And for people with jobs that may require relocation or have shorter holding periods because they are looking to trade up, renting makes sense since transaction costs can destroy the profitability of a short term purchase. To illustrate, if you bought a house for $100,000 and needed to sell in 2 years, you would need +4.9% return/year assuming 10% total transaction costs (5-6% brokerage commissions and 2-7% closing costs - see here for a sample of closing costs) just to break even! In contrast, renting gives you the flexibility to relocate or experiment without any risk for financial loss. This can ultimately equate to better control over your life as opposed to being tied down by your house!
4. No Hassle Living. One of the psychological and lifestyle benefits for renters is that they can more fully enjoy the home that they live in without having to be concerned about repairs or ongoing maintenance. While there's certainly some responsibility for basic upkeep, the primary burden of plumbing repairs, gutter cleaning, etc. typically falls to the landlord which easily translates into many more weekends for the renter to enjoy the home.
5. No Pressure to Over-Invest. Whether driven by a desire to "keep up with the Jones" or a need to personalize/customize their home, many American homeowners buy into the prospect of never-ending DIY home improvement projects when they purchase a home. While there are many remodeling projects that are certainly warranted given the age and condition of the home or lifestyle needs, often these become a slippery slope to irrational over-investment in a depreciating asset that is not likely to be recouped. Few people realize that real estate prices are driven by two major components - the land on which the property is built which tends to appreciate over time given the scarcity of good locations, and the actual physical dwelling which depreciates as the property ages. So over-investing in the dwelling can be tantamount to simply throwing money into a rotting asset! Just to cite a specific example that I know in the San Francisco Bay Area:
- A couple bought a brand new home prior to the peak of the bubble for $1.3M and subsequently spent $500K on various upgrades and customizations.
- At the peak, the home was estimated by inflated appraisals to be worth somewhere between $2.1 - $2.5M, a tidy gain on paper of $300-$500k which further justified to the owners that their "investments" are paying off
- Once the bubble burst, the home value fell to $1.1M, well below the initial purchase price and the couple now has no hope of ever recovering their investments in upgrades, not to mention the loss on the home overall, especially given that newer homes have been built in their area.
To be fair, while I've highlighted several financial and psychological benefits of renting, there are certainly some obvious disadvantages. The first is that there is less stability as renters may be forced to move for a myriad of reasons once the lease expires. Particularly in this environment, with so many landlords feeling the aftershocks of the real estate fallout, many good qualified renters have been forced to move due to the deteriorating financial situations of the landlords. And for those looking to transition from homeowner to renter, there are numerous issues to consider. For many people, the hurdle may be the mindset shift from the American dream ideal or even the logistical inconveniences of a move. But at the end of the day, I hope that this article at least provides another lens for choosing between the rent vs. own decision.