Your return on rent is always -100% every month, forever. Some will say that rent is not an investment, but an expense, and they are absolutely right! Rent is never an investment because you will never get a return on it, no matter how hard you try. At the end of 10 years, your $2,000 a month rental “investment” will net you negative $240,000 in after tax dollars, which equates to over $300,000 in gross income.
When you buy, your mortgage is also an expense, but like a derivative with time value, your mortgage also has the optionality as an investment. You can surely lose a lot of money in your home if you choose to sell it in a down market. However, at least you have the option of profiting as well, and that is worth something. Study basic derivatives, and you will get a better sense of optionality. It’s one of the most important attributes in any investment.
Weighing The Risks
Take for example Apple Computer in 1983. Let’s say the company’s cash per share is $10, and it’s trading at $11 per share, despite having a new product called the Apple Macintosh ready to be launched in the spring of 1984. You can’t believe the market is only assigning $1 worth of optionality to Apple’s new product launch given the dire economic scenario of the early 80’s.
As an astute investor, you realize that the worst case scenario is that the stock trades down to its book value of $10 per share, because after all, you can theoretically liquidate the company and take in the $10 in cash and the development and marketing costs have all been paid for.
In many areas, your rental yield will cover your mortgage costs thanks to a decline in prices and a stickiness in rents. In other words, you have a good amount of optionality. Let’s say your house costs $2,200 a month after property tax, mortgage, and normal maintenance costs. If you suddenly lose your job and all sources of income, you can simply rent it out for $2,200 a month. What’s the risk in that?
The Time For Homeownership
The time to start thinking about home ownership is when you have built up a cash hoard worth at least 30% of the value of the house for a 20% down payment and a 10% buffer. Furthermore, you see yourself being in one place for at minimum 5 years and better yet, 10 years. These two variables will dictate that home ownership consideration should most likely being in your late twenties or thirties.
If a great place comes on the market but it’s wildly out of your budget, don’t try to convince yourself that you deserve it. Keep looking and stick to what you can afford. And don’t be afraid to negotiate if the seller is eager and your competition isn’t chomping at the bit. Just avoid insulting the seller or wasting time by putting in a low ball offer that they won’t even consider.
Always think about your career and family situation as well when deciding if you should buy property. Figuring out when is the best time to buy property isn’t only about analyzing the state of the real estate market, it also needs to be based on your lifestyle for the next several years and the health of your financial situation.Ask yourself questions like could I be transferred to a new corporate location in the short term, am I/my spouse possibly going back to school full time, am I at risk of losing my job, are there any tax advantages if I relocated to a nearby neighbor state instead?
Living Well
Despite my example of Apple computer and optionality above, the secret to home ownership is to not treat your home like an investment. You need to treat your home exactly what its primary function is for, shelter. One of the main reasons why I am a homeowner is because the rental stock is of poorer quality than the ownership stock in San Francisco. Due to rent control, many rental units are not updated because landlord have no incentive to upgrade. As a result, there is a vicious cycle of more and more crappy rentals.
I set a maximum willing to pay cap of $2,000 a month in rent. Once I realized I’d have to pay more for a well-located two bedroom/two bathroom apartment, I decided to buy. My goal has always been to find the most comfortable living arrangement at a reasonable price. I’m no longer a fresh college grad willing to slum it in a crappy one bedroom or have a roomie in an equally shoddy two bedroom. I’ve moved on. Life is too short to live like a pauper. I have the same philosophy with spending whatever it costs for the best mattress possible. We spend so much time in our homes and on our beds it behooves us to spend up.
I’ve had some smug friends say they are saving so much money by renting. Fantastic! But when I go over to their place, I simply realize they are getting what they’re pay for, a dump. At 30 years old, they are living in the same crappy type of apartment as they were when they were 25. Once again, they aren’t saving any money, they are throwing their after tax income away on an expense which they have no claim over. Worse yet, they have no optionality.
Be Happy With Your Great Place
If you have a great place you are renting that you love, definitely hold on to it and keep on renting. Just don’t be under the illusion that you will one day get rich from renting. Instead, you are guaranteed to lose it all, 100% of the time. You’re right, rent is an expense that will never, ever go away as long as you live.
In this age of quantitative easing, low rates, a depreciating dollar, and healthy rental yields, if you have the 30% down payment, and know where you’d like to settle down, consider home ownership. You’ll be amazed by an indescribable feeling once you buy your first place that nobody tells you about.
Perhaps it’s the optionality value I discussed. Or perhaps it’s a sigh of relief knowing that you’ll never get kicked out of your home again and can do what you please. And in the event that all else fails, know that the government is on your side, giving your free money and subsidizing your mortgage every step of the way!
Recommendations:
Shop around for better mortgage rates. LendingTree Mortgage Refinance offers some of the lowest refinance rates because they have a huge network of lenders to provide mortgage loans, home equity loans, and home equity lines of credit. If you’re looking to buy a new home, consider using LendingTree to get multiple offer comparisons in a matter of minutes. When banks compete, you win.
Regards,
Sam
Sam, thank you for requiring people to have 30% of the purchase price of their home before they buy. It is ludicrous to me how much people overvalue that feeling of buying their first home, if you have to pay for mortgage insurance they you don’t deserve to buy a home. That sounds harsh but I have had several friends who have gotten way in over their heads with their homes. Do you think that maybe the flexibility of renting might be worth something as well? My wife and I may never buy a home, simply because the career field she wants to work in offers free living expenses (rent, food etc.) and we would love to save all that money over the course of our lifetime.
We had a meager ~3.5% down payment when we bought our house last summer. That all went to taxes, fees etc. and we ended up owing only a tiny bit less than the sales price.
It was still worth it compared to renting, both from a financial and personal standpoint, and we have been paying off aggressively since then. $25,000 in 6 months. And we could easily sell for 45,000 above what we paid, but we won’t 🙂
That makes perfect sense! While I do recommend renting until you know 100% in your mind that you want to own a home and have some stability, purchasing a home is one of the best things you can do.
I totally agree that buying property is a really good investment when you’re stable and can afford it. It’s exciting to own and also protects yourself from wasting your savings on unnecessary things.
Love the specific targets of 30% and 5-10 years in one spot. Where were you when I was younger? Great point with the Apple example. I finally bought last year with the historically low interest rates pushing me over the edge. Plus Baby Buck needed more space to run. Thanks!
It’s good you got in when you did and took advantage of those low rates!
I wish we would’ve waited longer to buy our first home. We had been living above the funeral home where my husband lived FOR FREE, and could stay there indefinitely (we didn’t have kids yet). I wish we would’ve stayed put for a few more years and saved more before buying our first place. We literally had no bills except for one small car payment. We didn’t even have to pay utilities.
Share with us how you guys got to live for free though? Was the funeral home part of a job perk?
I like your prerequisites, Sam, for buying a house by saving 30% cash down payment and not likely moving for at least 5 to 10 years. We have been in our current house for 15 years. I thought it was interesting to hear the surprise in our realtor’s voice 15 years ago when she discovered that we were paying 40% down.
40% is huge! Nice job. I’m happy with a 20% down payment and a 10% buffer.
15 years later, I bet you’re so happy you bought your house yes?
A lot of people don’t think about the great tax benefits of owning a home versus renting. Renting may seem cheaper, but if you’re smart about the property you buy, owning can often come out cheaper when you look at the all in costs after tax deductions. Owning property is great but only if you can afford it and are ready for the responsibility. Homes need love and attention in addition to being able to pay the mortgage on time every month!
You make a good financial analysis of buying a home versus renting. I especially like that you recommend 30% down, as most people I know (including myself) were no where close to that when they purchased.
I recently sold my house and went back to renting. We are renting a very nice place (on par with the house we owned), and financially, we are close to what we were spending on the house, with some added benefit being that power and water are cheaper in our smaller place.
I would like to mention the “time” factor. Time (and the value of your time) is often overlooked when considering a home purchase. When I owned a house most weekends were spent with at least one day tending to house related tasks. Things like mowing the grass, refreshing the landscaping, tending to the pool, fixing things, and cleaning things. There was always something that needed to be done.
Now that we are back to renting we have more available time. Now that I’m renting an apartment, I don’t have to spend my weekends with house related chores. All the landscaping, pool care, and apartment maintenance is handled by the landlord. All I’m left with is some cleaning and straightening that can be handled in a short amount of time. That leaves my weekends free to spend doing fun things with the family.
Another added benefit (in my area full of urban sprawl) is that renting an apartment puts me closer to shopping and dining. That has allowed me to walk or bike to get groceries and to eat dinner out.
I know this article was strictly about financials, but I wanted to add my comments since some of the other benefits of renting are often overlooked.
There’s definitely some great benefits renting as you have mentioned.
I recommend having 30% of the home value in cash so you can put 20% down and have a 10% buffer.
Do you ever plan to own again?
In our area, property is not really an investment right now. Neither is rent though (never will be, as you mentioned). We ended up buying a house and got a really really good price on it because it was a weird time for the market. Hopefully we will be able to sell it for at least what we bought it for, in a handful of years when we decide to sell.
Gotcha. At least you bought low. Where do you live currently?