Chapter 21 – Renting vs. Buying

“I figure if I have my health, can pay the rent and I have my friends, I call in ‘content’” ~Lauren Bacall (Actress)

In Chapter 8 – Renting, we introduced renting as part of your expenses.  Then in the previous chapter, we explored the rental market even further.  In this chapter, I want to go even deeper into the renting vs. buying decision.  I often hear the common, yet incorrect, saying of, “renting is throwing your money away.”  I disagree—the decision of renting vs. buying, like all financial decisions, is based off timing.

In Chapter 7 – Housing, we discussed that all housing expenses shouldn’t exceed 35% of your (post-tax) income.  So, before you decide on whether you want to rent or buy, you should first focus on making sure you don’t exceed 35% of your income.  Renting vs. buying comes with different expenses that may encompass that 35%.

Renting a property includes paying your rent, utilities, and renter’s insurance.  Rent is normally higher than a mortgage.  Unless the property owner pays for a utility, utilities are the same whether you’re buying or renting.  Renter’s insurance is normally lower than homeowner’s insurance because renter’s insurance pays for all your belongings inside the house and the damage you may or may not cause the home.  Homeowner’s insurance is for both your belongings and the property itself.

When you know how much 35% of your income will be, the next thing that you should research is home prices.  Dramatic decreases in home prices can instantly wipe away wealth and rapidly increase the financial risk of property owners.  In the 2008 housing collapse, many properties saw a 50% reduction of home values from their tops.  In my hometown of Rosamond, California, average prices went from $300,000 to a low of $165,000.

Renting vs. Buying
Price History of Rosamond, CA

If you had bought at the height, you would’ve lost $135,000 in less than 9 years.  Renting would’ve shielded you from that massive loss—especially if you renegotiated the rent as the housing prices fell.  Additionally, buying a house costs quite a bit of upfront money.  There are paperwork costs, down payments, realtor fees, and upfront taxes.

Suze Orman has 4 signs why you shouldn’t buy and one of them is those large upfront costs.  Another is if you have a lower credit score.[1]  It’s not just the upfront costs that can be worrisome either.  There are routine costs like Homeowner’s Association (HOA) fees and repairs.  When you take out a mortgage, the interest rate depends on how much you put down and your credit score.  When you rent, your credit score is a simple “to rent or not to rent,” and lower credit scores are more easily forgiven when renting.

With interest rates being so low these last several years, the U.S. Census Bureau shows U.S home ownership is at near highs with 64.3% of Americans “owning” their home.[2]  I put owning in quotes because many Americans don’t actually own their homes. The banks do. While mortgage debt-to-GDP rate is lower than the high in 2010, our real mortgage debt is higher than it’s ever been.[3]  As interest rates rise, we’ll probably see a rise in foreclosures and short sales, and then a drop in the home ownership rate.

This is a lot to consider for renting vs. buying, but luckily enough, many finance sites have rent-to-buy calculators.  My favorite is here at Nerdwallet.com.  The assumptions are listed at the bottom if you want to dive deeper into the calculations.  Michael Dinich, at Your Money Geek, as a great article using Smart Asset’s tool.  Like NerdWallet’s calculator is breaks down all the costs associated with buying a house and compares it to a renter paying rent and renter’s insurance.  Both of these sites give you an estimate and I recommend running through these calculators before making the decision of renting vs. buying.

A 20% down payment is a major part of the factor.  Typically, the deposit a renter pays is the first month’s rent and they receive the back when they move, assuming there’s no property damage.  You may have lost pennies on interest you could’ve earned, but it’s not a sunk cost into renting.  20% down payments help homeowners avoid the Premium Mortgage Insurance (PMI) and get the lower interest rates.

Down payments are great for lowering the loan cost, but can disappear instantly if house prices crash.  Once you put the money down, it lowers the value of the loan, but has no impact on the price of the home.  Remaining loan balance isn’t a factor for nearly any home buyers, and in many states is not known to potential buyers.  In the price history of my hometown, shown above, 20% of a $300,000 house is $60,000.  Your entire down payment plus an additional $75,000 was an unrealized loss if you sold ($60,000 down payment + $75,000 additional loss = $135,000 the loss mentioned above).

This is one of the assumptions of rent vs. buy calculators.  Conversely, if home prices come up, then down payments provide high returns and is one of the reasons owning properties is a staple in the financial world.  For example, if you put $20,000 down on a house that costs $100,000 and it goes up $50,000 in value in 3 years, then you made 250% gain with just $20,000 invested.  This “quick money” is what attracted so many investors to the housing market prior to the 2008 collapse.  Many banks started offering no-down payment or interest-only loans, so there was little-to-no cash outlay for people to make tens and hundreds of thousands of dollars in just a couple of years.

Renters experience an opportunity cost when there are rising home values.  If you look at the price history above, if you started renting in 2000 when the house prices were at $85,000, then you would’ve missed the rapid increase to $300,000 by 2006.  But still, the renter would’ve walked away with zero liability.  And this is the bottom line for renters perfectly said here on the MD Wealth Management site, “ Renting offers greater flexibility, both in a life sense (peace of mind knowing you aren’t responsible for the furnace when it breaks) and in a financial sense.”  One of the best parts about renting is not having to worry about paying for repairs, which in some cases can be extremely costly.

One of the real risks to renting, like I mentioned in the previous chapter (link), is the over-commoditization of properties.  Due to the interest rates being so low for so long, large companies called Real Estate Investment Trusts (REITs) have bought many properties and can provide subpar customer service to its renters because of how massive these companies are.

REAL ESTATE INVESTMENT TRUSTS (REITS) INTRODUCTION

I’m excited to announce a new feature of the website and that’s the Financial Genome Project stock tracker.  A key part of the financial genome are the companies and the shares they distribute (stocks).  We’ll go into what stocks are in a later chapter, but this is a good time to introduce the largest apartment REITs just to get a glimpse of the scale of the commoditization of properties.

REITs own approximately 511K properties across the United States.[4]  Now, these are whole properties such as an apartment building and I wasn’t able to get data on how many individual units that are owned by REITs.  In June of 2018, REITs owned approximately $3 trillion in real estate assets which is about 10% of the U.S.’s $31.8 trillion real estate market.[5]

10% doesn’t seem like much, but remember, 64.3% of all properties are owned by actual homeowners, which is $20.4 trillion of the $31.8 trillion total value.  This means that $11.4 trillion of that is people renting.  REITs own about $3 trillion of that $11.4 trillion or 26.3%.  So, 1 out of 4 properties for rent is owned by a REIT.

It would be unfair to say all rental units owned by large companies have poor customer service.  Like any purchase, you’d have to do your research.  And it would also be unfair to say all homeowners provide good customer service, especially, given my own personal story I shared in the previous chapter with an elderly, inattentive homeowner.

Here’s a new part of the website.  I predict that apartment REITs will see higher revenue and profits, even as rents fall, when interest rates lower the amount of property owners.  You can navigate to our new stock tracker and see the quality of my economic predictions.  For now, this is just me providing my analysis, but in the future, I’d like an economist forum to weigh in and provide predicative analysis for my readers.

The five largest apartment REITs according to Seeking Alpha are Avalon Bay Communities (AVB), Equity Residential (EQR), Essex Property Trust (ESS), Mid-America Apartment Communities (MAA), and UDR (UDR).[6]  You can track these stocks on my new stock tracker.

SUMMARY

Renting vs. buying is a big decision.  I hope this deeper dive into the rental market provided some useful tips before making the decision.  We also went over a brief introduction in REITs and introduced my new stock tracker.

DISCLOSURE:  I don’t personally own any of the REITs mentioned in this article.  These stocks are for information only and not recommendations.

[1] https://www.suzeorman.com/blog/4-signs-you-should-rent-not-buy

[2] https://www.census.gov/housing/hvs/files/currenthvspress.pdf

[3] https://fred.stlouisfed.org/graph/?g=I5G

[4] https://www.reit.com/data-research/data/reits-numbers

[5] https://www.zillow.com/research/total-value-homes-31-8-trillion-17763/

[6] https://seekingalpha.com/article/4124788-reit-rankings-apartments?page=3