Renting is a Waste of Money
Has anyone ever told you that directly, or do you just "know" is true? Part of the American Dream is owning your own house. Think about how romanticized this is: you and your partner sit on your freshly painted porch, overlooking a beautiful lawn, and watch your children play in the sprinkler. You smile to yourself, because your future is secure. Every day you're "building equity" in your home. Your family, friends, and neighbors can tell you've really made it, you're living the good life.
This is the way it's sold to us, often subconsciously. But does owning a house always make financial sense?
A Case Study
This spring, we were looking at buying a house. Our lease was expiring, and we were about to have our first child. Time to "settle down" and "get serious". We opened up Zillow and a house had just listed on our street, three doors down. We like our neighborhood, so we scheduled a showing. As we walked through, we noticed that the floor plan was identical to our current rental. Same staircases, fireplaces, trim, etc (most of the houses on our street were built at roughly the same time so this isn't too surprising). This was a great opportunity to do an apples-to-apples comparison of a house with the exact same layout, square footage, and neighborhood and see how renting compares with owning long term.
The "Simple" Math
When people look at buying a house, they often don't do any analysis at all other than comparing the sticker price of the mortgage to their current rent. If they are a little bit advanced, they'll do some really high level calculations to see if it makes sense. In my experience the default calculation people do in their head roughly looks like:
(current monthly rent - mortgage payment) * years in the mortgage * 12 + value of the home = equity gained vs. renting
Let's break this down a bit. In our case, our rent is $1,700 per month. The house was listed at $299,900. According to Zillow, if we payed the default down payment with current interest rates, we'd be paying $2,041 a month. So, to live in a similar house, we'd be losing $341 ($1,700 - $2,041) per month. But after 360 (30 * 12) months, we'd own a house that was worth 299,900. Is that worth it? Let's see:
($1,700 - $2,041) * 12 * 30 + $299,900 = $177,140
Wow! We realized we'd have $177,140 more equity when our mortgage was over, it was definitely worth it for us to buy the house! We bought it and now we're living the real American dream. We're much happier and more fulfilled, and I can tell that our infant son respects me more. The end.
The "Correct" Math
"Wait", our astute readers will say. "Didn't you forget to factor in the down payment, home repairs, and the time value of money?" Yes, intelligent reader, you are correct. Our math above was simple and easy to understand, and helped us justify the home purchase to ourselves, but it's not correct. Let's try to get a little more advanced. We'll need to maker several assumptions to project the financial consequences of buying vs. renting.
Down Payment
We'll assume we pay the standard 20% down to avoid additional insurance costs, so that's $59,980.
Initial Repairs and Rennovations
Although the floor plans are practically identical, the new house needs several updates to match the quality of our current rental. The new living room has old cheap carpet and the dining room has old linoleum over clearly buckling hardwood instead of the refinished hardwood floors in our current place. The concrete steps leading up to the house are caving in, and the brickwork needs some repointing. The kitchen has no dishwasher, and the cupboards are dated. Using various home remodel estimation sites like this one I added up the repairs and estimated it will cost us at least $35,000 (on the low end) to fix the new house up to our current standard, and we'd recoup around $28,000 (80%) of those costs in the value of the home.
Ongoing Maintenance
Now that We can't rely on our landlord for repairs, the conventional wisdom says to budget between 1%-4% of our home's value in maintenance costs every year. We'll use the lower estimate of 1% so people don't think we're skewing the numbers in favor of renting. Our first year of ownership, that would be $3,279, but as the value of the house grows over time our maintenance costs will grow too.
Rent Increases
We live in a relatively low-cost metro, and historically rent increases have been modest. The best data I could find is that rents have increased about 1.14% annually over the last 20 years in my city.
Returns for Housing vs. Equities (Index Funds)
Our final piece of data is the returns we should expect for equity (renting and investing in stocks) and housing. Usually, you'll see me cite a return of 6.7% for equities. I got that number from the excellent book Stocks for the Long Run by Jeremy Siegel. But while looking for a rate of return for housing, I found this paper which only looks at the last ~150 years. So that we're using fair benchmarks from the same time periods, I'm going to pull both my equity and my housing return estimates from their USA average numbers: 8.39% for equity and 6.03% for housing.
And the Winner Is...
Great! We have our data and can plug everything in. Here is the spreadsheet that I used to do my calculations. We're going to calculate the value we'd have in both scenarios (renting vs. buying) and see which is better after 30 years.
If We Buy The House
Our housing return is very simple. We take the initial purchase price + the recouped value of our initial repairs and multiply it by our growth rate every year for 30 years. Ultimately, our $327,900 initial investment grows exponentially to $1,899,346.75. Wow! Pretty amazing.
If We Rent and Invest the Difference
This is a little more complex. First, we start by investing our down payment and the initial cost of repairs. Then each year we multiply the previous year by our equity growth rate, and add the difference between renting and owning (mortgage payments + maintenance costs - rent payments). After 30 years, our investments have grown to $2,039,469.54!
Over 30 years we actually make $140,122.78 by renting.
But Did We Make the Right Assumptions?
Hard to say. In our example we used a low estimate for our intial repairs and maintenance costs. This is an old house, so those both could be significantly higher (which would tip the scale even further towards renting). When I crunched the numbers for myself I tried a few different values for growth rates, maintenance costs, down payments, etc (and you should too if you're trying to project something like this). In the end, the numbers didn't add up. I couldn't justify buying and we decided to renew our lease. But I loved finding an apples-to-apples example to illustrate that renting can often make more financial sense. And, that's only including the first-order costs. There's a few things I didn't take into account which in my experience skew things hugely in favor of renting, at least for young professionals in the early part of their careers:
Pros for Renting:
- Owning a home means you're putting a lot of your eggs in one basket. You're betting that your neighborhood will perform at least as well as the national average. How do you know you're picking a neighborhood that will be desirable in 30 years? It's hard to predict. In contrast, if you're invested in a broad range of equities (like a good index fund), you're invested in the entire U.S. economy. What's more likely, your neighborhood collapsing or the entire U.S. economy collapsing? And if the entire U.S. economy collapses, your house value likely will too.
- Owning a home locks you into one location. If you are starting out in your career, this can be a huge disadvantage. Switching jobs is absolutely critical to advancing as quickly as possible in some industries (probably another blog post on that later). If you buy a house, it's significantly more painful to take a great opportunity in a different city/state and super-charge your career. Selling a home is very expensive and stressful, which realistically may mean you pass on an amazing career opportunity cross-country.
- Owning a home is a huge pain. Unless you would choose to do home improvement tasks in your free time, owning a house is way more work than renting. Don't underestimate the value of convenience. As someone who's flipped a home before, it was one of the most stressful experiences of my life. Being able to submit a request and let your landlord take care of it is an amazing quality of life benefit.
Cons for Renting:
- You can have a terrible landlord. I've been there, and it does suck. But, the nice thing about renting is that you can always move at the end of your lease (or earlier depending on the specific terms).
- Your rent can be increased. Property taxes can also increase for homeowners, but subjectively I feel like rent increases are more common. I'd need to do more research to fully compare the risks.
- You won't be able to make major modifications to your living space. It's not "yours" to do as you want. One word of caution, years ago I purchased a home thinking renovations would be super fun and rewarding and discovered that the idea of doing renovations is way more fun than the actual work involved. Once I actually started a project, the ongoing rennovation was just a constant nagging annoyance that limited my ability to enjoy my freetime (and honestly impacted my mental health). But, if you love home improvement projects, you may have a different experience.
- Owning a home is a status symbol. People will see you as mature and adult if you buy a home. They won't show the same respect for your spreadsheet proving that renting actually makes more financial sense.
- Rental markets can be limited. If you are single or without kids, you may have many options. But if you start to add children/pets to your family, the rental options may become more sparse.
Closing Thoughts
Optimizing every financial decision is not the #1 priority in life. If you really want to own a home, awesome. It's not a terrible investment, and it could potentially bring you a lot of joy. But, if you're feeling pressured to buy a home? No. Stop. Don't let other people push you into their version of the American Dream, especially it if will limit your financial returns and possibly your career growth. Think for yourself and crunch your own numbers (feel free to steal my spreadsheet for personal use).