Renting vs Owning? Perhaps Renting isn't all that bad... For now.

It seems like common sense to assume that renting a house vs buying is just a giant waste of money.  However, with mortgage rates and house prices extra high and housing inventory low, this is not necessarily an opportune buying time for many. There is, however, a handy and simple calculation you can do to figure out whether renting or buying makes sense.

I’m Darren Leader and today, I hope to provide you with some tips to help you make an informed decision on whether to rent or buy your home in the current environment.

First, let’s get something out of the way.  I believe in the long-term wealth-building potential of real estate.  I have seen many clients grow their wealth over time through real estate, and believe that most investors benefit from having exposure to real estate in their portfolios.  However, with current house affordability at the worst levels since the mid 80’s, as you can see from the chart below, (meaning that houses are less affordable now than they have been at any time over the last 40 years!), it is worth revisiting the traditional ‘rule of thumb’ financial advice that says that you should generally buy your home versus rent.

 If the housing market behaved as many other markets do, prices would have fallen over the last several years. Mortgage rates have risen sharply since the Covid pandemic receded, as the Federal Reserve has raised interest rates to lower inflation.

Higher rates in turn make higher monthly mortgage payments for new homes. This reduces demand and should cause home prices to fall. But prices haven’t fallen. Why is that? One reason is that many homeowners feel an emotional attachment to their home value and set a price they think they deserve. Rather than cutting the price to make a sale, they pull the house off the market.  In addition, anyone looking to sell a house, generally also has to buy a house to move into.  Unless you have to move due to a life change like a job relocation or divorce, you are unlikely to choose to sell a house with  a 3-4% mortgage rate to buy a house with a 7-8% rate.  This in turn reduces supply of homes on the market and keeps prices high.

The result is that home prices in many places are even higher today than they were when mortgage rates were very low, as you can see in the chart.

Renting vs buying always involves trade-offs. Buying allows homeowners to invest in an asset that they can later sell instead of paying a landlord each month. It also brings the security and comfort of living in a home you control. But when you buy, you are effectively paying tens of thousands of dollars to real estate agents. You also tie up money in a down payment, instead of being able to invest it elsewhere plus you’ll have to pay for any repairs.  You’ll bear the risk that house prices will fall — perhaps drastically. Take another look at the home-price chart on the screen.  After the housing bubble of the early 2000s, prices didn’t return to their previous peak for more than a decade.

Importantly, buyers will have to pay mortgage interest to banks. In the early years of a most payments will go to cover interest, not the loan’s principal. Although the mortgage-interest tax deduction does reduce the effective cost of payments, it doesn’t eliminate it. These dueling factors argue for buying a home if you can afford to do so and you plan to live there for a long time but if you think you will move in several years, renting often wastes less money than buying, as you have effectively just paid a lot in transaction fees and interest, and likely have not built up that much equity or paid down much principal.

The current housing market has made renting even more attractive. If you find an affordable house where you’re confident you will stay for a decade or longer does buying may make sense in many places. According to Moody’s Analytics, prices in parts of the Midwest and Southeast are very reasonable. A good rule of thumb is to lean toward renting unless the rent ratio in your area — the purchase price of a house divided by the annual cost of renting a similar house — is below 18. In many cities, the average ratio is now above 25. Here’s an example:

If buying a $400,000 house, that you could rent a similar version of for $2,000 per month ($24,000 annually), the rent ratio is 16.67 ($400,000/$24,000).  In this scenario, the ratio is below 18, and it likely makes sense to buy, as the cost of rent is high relative to the purchase price of homes in your area.

On the flipside, if the same $400,000 house could be rented for $1,500 per month ($18,000 per year), then the rent ratio is 22.2 ($400,000/$18,000), and it likely makes sense to rent, as the $1,500 monthly payment is quite good value compared to what it would cost you to buy.

As with all rules of thumb, the decision to buy or rent should be made on your unique circumstances, goals, and preferences. Taking into consideration your finances, market conditions, future plans and risk tolerance can help to decide which is best for you now.

If you’d like to set a time for a discussion of your personal finances, call our office at 518.406.5624 or visit our website at simmonscapitalgroup.com.