Chapter 8 – Renting
“I’m a big believer in home ownership, but only if it makes financial sense.” ~Suze Orman
*Personal Finance Tip: Renting is a great option if it’s short term, you don’t have money for a down payment, or the cost of renting is cheaper than the cost of a mortgage.
Renting is usually the first option we take for housing. We usually live in a small apartment with few amenities. Some utilities are usually covered. Other times in our lives may make us rent a house. When renting a house, we usually have to pay for most utilities. As we discussed in Chapter 7 – Housing, you should try to keep your housing costs under 35% of your post-tax income. Whether it’s an apartment or a house, renting is when you don’t own the housing and you pay someone else that does own it. In terms of assets and liabilities, you have neither when renting. Depending on the details of your rent agreement, you can simply walk away and choose another housing option. This is an important benefit to renting. First, let’s discuss why renting can make financial sense.
One of the first reasons why renting makes financial sense is when you need housing for the short-term. You can rent an apartment in less than a day. In most cases, you can’t buy or sell a house in less than 30 days. I’ve had to rent several times in the military, knowing I was only going to be at a certain location for two years. You don’t have to worry about short-term housing fluctuations or a home inspection with thousands of dollars of repairs, days before you plan to sell.
Another reason why renting can make financial sense is if you don’t have a 10-20% down payment for purchasing a house, but you have to find a place to live. Once the sky-high interest rates of the early 1980s started to reduce, more people started buying homes. Then in 1995, and in what some economists believe was the start of the 2007 housing financial collapse, President Bill Clinton rewrote the Community Reinvestment Act to “force” lenders to lend in low-income neighborhoods. Nearly two decades later, people without any financial knowledge were getting adjustable-rate mortgages starting at 50-85% of their post-tax income with zero down payment. A 20% down payment eliminates the premium mortgage insurance (PMI), gives a safety cushion of equity, and potentially reduces the interest rate of the mortgage. PMI is an insurance to protect the bank from defaults that you have to pay if you buy a home.
One of the last reasons, though my three reasons are not all inclusive, is if you have a low credit score. Your credit score determines the interest rate you’ll pay when you get a mortgage. If the interest rate is too high, you’d be unnecessarily paying too much interest. You can Google free rent vs. buying calculators and quickly see how interest rates make renting a better option. So, these are the reasons why renting can make more financial sense than buying. Now, let’s look at how renting impacts the financial genome.
Approximately 37% of the U.S. rents (close to the same levels in 1965, though not indicative of anything). Home ownership and renting rates don’t drive an economy. It is intertwined with so many connections in the financial genome. For example, 57 % of Germany was renting in 2014. This trend is neither negative or positive. Germany has a different financial genome than the U.S. A potential reason for the difference is the U.S. provides a tax deduction for interest on a mortgage where Germany does not.
As discussed above, when you rent, your money goes to the entity that owns the property. This could be an individual or a company. The owner pays property taxes and is ultimately responsible for the utilities the unit consumes. Some apartment complexes are owned by individuals as investment properties. Some apartment complexes are owned by large companies. The top 5 largest private companies own nearly 700K apartment complexes. On a larger scale, you have Real Estate Investment Trusts (REITs) that own a large portion of the U.S.’s apartment complexes. The top 5 apartment REITs have a market capitalization (total stock outstanding times stock price) of $105B, owning nearly 500K apartments. In chapter 7 we discussed that the total world value of housing is $217T. As of December 2016, the total US value was $29.6T. If you’re at the point where you are about to rent your first apartment, then you’re stepping into the exciting housing connection of the financial genome.
On a side note, REITs offer a unique investment opportunity. REITs are governed strictly. They must maintain at least 75% of their capital in the sector they registered with. REITs must pay out 90% of their profits in dividends to shareholders. The average yield for the REIT sector was 8% compared to the 2.78% yield of a 30-year Treasury.
In a future chapter, we’ll discuss renting properties as an investment. When you rent, you’re giving your post-tax income to either an individual, a private company, or a publicly-held REIT. Here’s how the genome looks now.