Chapter 8 – Renting

Chapter 8 – Renting

“I’m a big believer in home ownership, but only if it makes financial sense.” ~Suze Orman[1]

*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.[2]  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).[3]  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.[4]  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.[5]  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.[6]  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.[7]  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%[8] compared to the 2.78% yield of a 30-year Treasury.[9]

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.

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

[2] http://content.time.com/time/specials/packages/article/0,28804,1877351_1877350_1877322,00.html

[3] https://www.cnbc.com/2017/07/20/there-are-more-renters-than-any-time-since-1965.html

[4] https://qz.com/167887/germany-has-one-of-the-worlds-lowest-homeownership-rates/

[5] http://www.multifamilyexecutive.com/news/nmhc-2016-top-50-largest-apartment-owners_o

[6] https://seekingalpha.com/article/4055959-reit-rankings-apartments

[7] https://www.housingwire.com/articles/38852-zillow-total-value-of-us-housing-reaches-all-time-high

[8] http://www.dividend.com/how-to-invest/comparing-dividend-stock-sectors-by-yield/

[9] https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

Chapter 7 – Housing

Chapter 7 – Housing

“Everyone has a fundamental human right to housing, which ensures access to a safe, secure, habitable, and affordable home with freedom from forced eviction.” ~National Economic & Social Rights Initiative[1]

“All of these government factors contributed to creating a situation in which millions of people were buying homes they couldn’t afford, in which the participants experienced the illusion of prosperity, in which billions upon billions were going into bad investments.” ~Forbes.com, 2008[2]

We are finally at the point where we can start discussing how spending our money impacts the financial genome.  In our lives, our expenses range on a spectrum from basic needs of survival to luxuries. How you define each expense is a personal choice; however, shelter is almost always considered a basic need, and is where we’ll start our spending.  A basic need is not to be confused with a basic right, which typically drives a political discussion.

Conventional and modern Certified Financial Planning uses a “28/36 rule,” which states no more than 28% of your monthly income should be on housing costs and no more than 36% of your monthly income should be on debt (includes mortgages, consumer debt, etc.).[3]  Dave Ramsey, a popular financial guidance advisor offers a similar recommendation of no more than 25-35% on housing[4].  Finally, the Bureau of Labor and Statistics determined 2015 average housing expenses were 32.9% of income[5].  So, based of all those numbers, the average real expense and advice is 30%, and that’s the percentage we’ll use.  Before we go further, you should check your housing costs to see how much you spend. Do you spend more on housing than 30%?

Once you’re an adult and no longer live with your parents, housing costs are generally within your control and your income is typically the basis for making that decision.  At about this point, your bias may have already kicked in and you’ve already decided that renting or buying is the best option. Please try and clear your mind of which decision is optimal because it truly comes down to timing, location, and the current financial landscape.  To have the greatest influence on the genome, the key to optimizing your income is to consider the Return on Investment (ROI) of every next dollar you spend. Additionally, when you make a decision to buy or rent, there is an opportunity cost with doing one or the other.  So, the decision to buy versus rent is based on the potential ROI and opportunity cost.

There are many types of housing that we get to choose from.  Due to my military background and my frequent moves, walking through the types of housing I’ve been in will help us navigate through the options many of us have.  The key takeaway is that I started small and moved to bigger, more expensive housing options as my income increased.

The first housing type I lived in as an adult was a military dormitory.  This was an extremely small (maybe 150 sq ft.) 1-bedroom, 1-closet, shared bathroom and kitchenette single’s room. It came furnished already, and I wasn’t required to pay for it—well, sort of.  The military pays for dorms by utilizing the funding the Department of Defense receives from federal taxes. In theory, the estimated cost of the housing is deducted from my pay.

After a couple of years, I moved out of the dorms and into a 1-bedroom apartment which had 1 bathroom, a small living room, and a kitchen.  The apartment was nearly 400 sq ft., which felt big compared to my small dorm room.  Once you move out of the dorms or military housing, you receive a Basic Allowance for Housing (BAH).  For civilians, this is just part of your normal salary. I spent about $350 a month and my salary was $1,200—roughly 30%.

A couple years later, we rented increasingly larger houses; the largest being 1,400 sq ft.  Each time we moved, I ensured that (even with all bills included) we never exceeded 30% of my salary.  The places we rented were slightly bigger or were newer.  We finally bought our first house nearly 4 years ago. Even with all utilities, our monthly housing costs are down to 20% of my salary.  This is the definition of living within your means.  If your housing expenses exceed 30%, then you have less income to go to all the other expenses.  Some people I’ve helped with their personal finances have housing expenses approaching 55% of their income.

Despite all the political missteps and the insatiable greed of lending companies and brokerages, if the public kept housing costs to less than 30%, the United States may have avoided the 2008 financial collapse.  Products like interest-only and punishing adjustable-rate mortgages would have been quickly exposed under the 30% model.  How much are you paying in housing costs?  Let’s look at how spending your salary on housing impacts the financial genome.

For starters, you are part of a $217 TRILLION global real estate market[6].  Isn’t that amazing?  Real estate is the combination of all apartments, townhomes, commercial buildings, residential homes and everything in between.  You have a choice of either renting from a company or an individual or buying your own property.  We must be careful on how we use the word “own” in our lexicon.  Typically, people need a loan to buy a house, and you’ll always need to pay property taxes.  So, while you have a loan, the bank technically owns the property.  It is also important to realize the actual value of a property is based on what a buyer is willing to pay.  Many people confuse this philosophy, thinking there must be an intrinsic value of real estate, making it better or worse than any other investment.

In the following chapters we’ll analyze the specific genome connections we connect to when buying or renting.  For now, consider us entering a new galaxy—the “housing galaxy.”  Housing is incredibly connected between all ranges of government, other individuals, corporations, shareholders, insurance companies, and billionaires.  You impact all of these.

[1] https://www.nesri.org/programs/what-is-the-human-right-to-housing

[2] https://www.forbes.com/2008/07/18/fannie-freddie-regulation-oped-cx_yb_0718brook.html

[3] https://www.goodfinancialcents.com/how-much-of-mortgage-house-payment-can-you-afford-based-salary/

[4] http://www.leavedebtbehind.com/frugal-living/budgeting/10-recommended-category-percentages-for-your-family-budget/

[5] https://www.bls.gov/opub/reports/consumer-expenditures/2015/home.htm

[6] http://www.savills.com/_news/article/105347/198559-0/1/2016/world-real-estate-accounts-for-60–of-all-mainstream-assets