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From Walton Sun 11/14/2009
There is nothing wrong with owning real estate. A popular local Internet bulletin board often touts that now is a good time to buy. They make a compelling argument: Prices are down, inventory is high and interest rates are at generational lows. Although owning a home makes sense for some people, for others, renting can be a much better financial choice.
For retirees who are living on their investments, high fixed expenses from a mortgage can be an economic albatross. Last year proved that investment portfolios can fluctuate, and fixed expenses require more assets to be withdrawn during downswings. Retirees with sufficient and sustainable cash flow are better suited for owning real estate and funding the subsequent mortgage. For others, renting is the best deal. Recently, both the client?s CPA and I agreed for their situation, renting was preferable.
?No brainer? is unprofessional, but entirely appropriate.
Is renting always better than owning real estate?
Always is a long time, but an esteemed colleague, Jake Engle, who practices in Seattle, pointed out that a house costs as much to own as a hedge fund (2-3 percent a year). Figure your annual expenses on maintenance, taxes, insurance and improvements. Residential real estate?s inherent illiquidity only compounds the problem.
Let?s crank up the old spreadsheet and run some local numbers. A hypothetical buyer purchases a home for $400K. For this illustration, they will pay 20 percent down, take out a 30 year mortgage at 5.125 percent, along with coughing up $208 and $200 for insurance and taxes monthly. Given the huge inventory of vacant homes, something comparable can be rented for $1,500 per month. Throw in $42 monthly for renters insurance ? yes, renters need insurance ? we see the renter?s monthly out of pocket is $959 less than the buyer?s ($1,542 versus $2,501).
So renting is always better. Not so fast; it depends on what you do with the $959. If you are like the typical American and blow it at Johnny McTighes or Chicos, then buying a home is much better than renting. Conversely, if you are disciplined enough to save the difference in a 401K and get a nice match from your employer, then you might be better off renting. At least in the short-turn ? the most critical variable is how long you own the home before selling. Even when the investment return is 50 percent higher than appreciation on the home (6 percent versus 4 percent), owning the home becomes the better deal financially if you stay put for 13 or more years.
Predictions are pretty dangerous, especially when they are about the future. No one knows what returns will be down the line. A low return (2 percent) on both homes and equities/bonds means the break-even point for renting versus buying is more than 15 years. A higher return (4 percent) for both lowers the break-even period to fewer than 5 years. The dramatic difference is due to the down-payment a home requires.
Logically, if residential real estate outperforms equities and bonds, then buying a home is a better deal. Because you are building equity (theoretically), buying a home outshines renting even if home appreciation lags equities and bonds.
Contrary to my friends who post online, there are no magic answers. Buying a home might be the best option but for some people, and under situations, renting is the way to go. Thoughtful and realistic evaluation should be exercised when weighing financial choices and giving investment advice.
Warren Buffet knows the best way to make money in real estate. Berkshire Hathaway owns HomeServices of America, the second-largest, full-service independent residential real estate brokerage firm and the largest brokerage-owned settlement services (mortgage, title, escrow and insurance) provider in the U.S.
