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Sunday, April 25, 2010

Rent vs. Buy: One person's actual data

Recently, after doing my taxes and figuring out how much of a tax benefit I get for my mortgage, I thought to myself, "I wonder if owning a house really does pay out the way everyone says?" So I proceeded to tally up every expense and benefit owning a house had compared to if were to have rented a place at the same monthly payment. I've lived in my place for over 8 years. I figured it would be a great real life, raw hard core data example to share with people.

In a nutshell, after brainstorming everything I could possibly think of, it came out remarkably even. In other words, if I had rented a place for the same monthly payment I was making, I would have come up no worse for wear. In fact, I didn't even include any time costs, like mowing the lawn, weeding the yard, etc. Here's a breakdown of the costs I came up with:

The equity and appreciation that we hear so much about is offset by realtor and repair costs. What's this I keep hearing about "throwing your money away" when you're renting because you're not building equity? Well, too bad when you sell it you need a realtor. And when the roof needs fixing or the runoff water needs to be re-routed to the front because it's flooding the back, that comes out of your pocket too. Not that I have any personal experience of that.

Here are the assumptions I used to come up with the costs:

Years in house

Purchase Price

Down payment investment
Assumed rate of return if you had invested the down payment
Sold Price
My own guess based off comps
Appreciation %
Based off the sold price
Down payment
20% of purchase price

Here's a breakdown of all the costs that went into the graph, and some more detail:

HOA fee
per year
I live in a house, so this fee isn't too bad
Closing costs
one time

per year

per month
Garbage, water, and sewer
Down payment opportunity cost
one time
Earnings if I had invested the down payment
Tax benefit
per year
After the standard deduction, and 25% tax braket
one time
See chart below
Realtor costs
one time
6% of sold cost
one time
Based off my own estimate of comps
Equity built up
per month
Average over the 8 years

And here are all my repair costs, in gory detail:

Siding and wall damage from storm (deductible only, insurance covered all)
New roof (plus deductible minus insurance)
Roof boots (3X)
Reroute runoff and drainage
New carpeting
New drywall from fixed leaks

Total Repairs

These repair costs are even before anything a home inspector might come up with when I sell the house. Plus I need to re-seed my yard, it's looking a little sickly. And the back fence needs painting. Again, I didn't count the money I paid my neighbor kid to mow my lawn, or the hundreds of dollars of mulch, or fertilizer, or the tree I had to cut down that died... I better stop and continue this analysis before I lose everyone.

So what happened to all the great benefits that my parents and everyone else told me owning a house had? I tried to figure out what went wrong. The answer, as you might expect, is the housing market. I had a 1% appreciation per year over 8 years. I did a little sensitivity analysis... if I had gotten a 3% appreciation per year, I would've been $30,000 ahead! Whoa. OK, so let's say it was -1% (where it was in a lot of markets I bet). And the answer is... -$25,000. I think that's what everyone calls "underwater."

So this whole idea of owning a house as an asset boils down to how well the housing market does. And it's a huge swing. This is what economists call leverage... you borrow money to invest in something. So owning a house is an investment. It's owning a very risky investment. Would you put down $30,000 and buy shares of any stock? How about borrowing $170,000 on that $30,000 and buying up that stock? So why would you do the same on a house?

Here's raw data. Buying a house is a very risky investment. All the equity built up and the tax benefits gets sucked up in realtor fees and repairs.

Yes, it's the American dream. I plan on selling this house, but I will probably buy another one in the future. It's great to own your home so you aren't at the mercy of a landlord or a lease. But go into it knowing it's very risky, and be able to mitigate that risk by having a LOT of money in reserve. Buy a house because you want to live in a house, not because it's an investment. And make sure you can truly afford everything that comes along with it (see above).



Brad said...

Nice writeup Dale. I read a similar analysis a couple years ago that really opened my eyes. It's amazing how much our assumptions can be wrong.

That said, I think the true benefit of buying vs renting comes after the 30 years mark, when your mortgage is paid off. If renting, you still owe a monthly payment. But if you've paid off your mortgage, you're only left with taxes and maintenance.

Anonymous said...

Dale, one thing that I didn't see in your list of costs (and forgive me if I just missed it) was property tax. This is a big cost that a lot of new homebuyers don't take into account when they are figuring out their monthly costs for owning their home.

Dale said...

@Brad - The "it's nice to not have a monthly payment" thing is very misunderstood, IMO. All the money you could've been invested on something else is spent on your mortgage. But your point is right, my analysis only goes 8 years.

@Anonymous - You know, I can't seem to find it either. I could've sworn that I had it in there. For me property taxes were $300 a month, making it a worse investment!

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