Rob Austin and his wife, Natalia, have a 10-month-old son, healthy incomes
and plenty of cash in the bank for a down payment on a house. But they are
happily renting a townhouse in Pasadena, Calif., with no plans to buy for now,
given the frothy prices in their area.
“As long as there is such a disconnect, where a couple like my wife and me
have to put down a gargantuan down payment and still have a large monthly
payment to get into a decent, and not necessarily nice, house, that is a game
we don’t wish to play,” said Mr. Austin, a 39-year-old business manager at a
biotechnology company. “When home price-to-income levels come back to a more
normal level, when that happens, then we will be the first to jump in. If that
never happens, that is O.K.”
More American households are renting, across all income levels and generations,
for different reasons. But when homeownership is the centerpiece of the
American dream, most of us have internalized certain ideals: Buying a home
builds equity, putting you on the fast track to building wealth. Renting, by
contrast, is essentially throwing money to the wind.
But with renters now accounting for 37 percent of all households, the highest level since the mid-1960s,
according to the Joint Center for Housing Studies of Harvard University, more
people may be renting for longer. Does that mean people who rent for extended
periods, perhaps decades — even a lifetime — are forever at a disadvantage?
“Arguing about whether rent versus buy is a better financial decision is
like debating active versus passive investment strategies, hedge funds versus mutual funds, Apple versus Google,” said
Milo M. Benningfield, a financial planner in San Francisco.
“Somebody’s going to be right in terms of higher returns in the future, but we
can’t know in advance who that will be — and it will be tough to quantify how
much risk was taken along the way.”
The arguments in favor of ownership are persuasive, particularly for people
who expect to stay in place for at least five to seven years but probably more.
A mortgage acts like a forced
savings plan, even if you’re paying the bank hundreds of thousands of dollars
in interest for the privilege of building equity. Call it the cost of enforcing
a positive behavior.
Buying also generally protects consumers from rising rents, while
traditional mortgage payments remain constant. Then, there is the fact that
buyers are using borrowed money to purchase an asset that is likely to
appreciate over a long period, though that can backfire as well (see housing
market plunge, millions of underwater borrowers, circa 2008). Being able to
call a place your own has a real, albeit intangible, value too.
How well any household will fare financially by buying or renting really
depends on factors no one can predict. Other studies have found that renters
who invest their down payment and any savings from renting as opposed to owning
often come out ahead.
Either way, most financial professionals would caution against viewing a
home purchase as an investment, particularly after factoring in the cost of
maintenance, taxes, insurance and the high costs of
buying and selling, though it’s difficult not to.
It may be hard for people living in bubbly markets to believe, but, over
all, home prices in the United States have risen just 0.37 percent annualized,
after inflation, for the last 126 years, according to calculations by Robert J. Shiller, an
economist who received the Nobel in economic science in 2013 and wrote the book
on speculative bubbles, “Irrational Exuberance.”
“Disregarding the special amenities that many people value in
homeownership,” Professor Shiller said, “it would be hugely better invested in
the stock market.”
And many people do accumulate substantial equity in their homes, which
often becomes a cushy safety net in retirement. A study by the Harvard Joint
Center found that, even after the housing crash, the median household who
bought a home after 1999 still accrued significant amounts of wealth through
2013 (though whites gained more than African-Americans and Hispanics).
Christopher E. Herbert, managing director of Harvard’s Joint Center, said he
believed the results could be tied, in large part, to behavioral incentives.
“The motivated savings up front and the forced savings over time,” he said of
accumulating a down payment and making mortgage payments.
There may also be
something about many people who buy. As Mr. Benningfield pointed out, they may
have other attributes that may contribute to their economic success.
Renting can still be financially advantageous under
certain circumstances. Consider the work in 2012 by the academics Eli Beracha of Florida
International University and Ken Johnson of Florida Atlantic University. They simulated a horse race
between buyers and renters, and concluded that in many cases, renters came out
ahead, at least during the eight-year stretches they studied.
Theoretical renters put their down payment in a
portfolio that often consisted of more than 50 percent stocks (the professors
created a portfolio that approximated the risk of owning a home), and continued
to invest any savings from renting. But this assumes that there are savings
from renting, which is not always the case, and that the renter is disciplined
enough to actually set the money aside.
The authors’ point, however, is that people often
blindly believe that buying is usually the smarter option. “Most of the public
drive to buy is without looking under the hood,” Professor Johnson said.
Another study, from HelloWallet, a unit of Morningstar, came to
similar conclusions in 2014 when comparing a hypothetical, moderate-income
family that bought, with one that rented, in 20 major cities across the
country. The study projects that median-income families, or those who earn
about $50,000, will often end up with more net wealth if they rent versus own
over the 10 years from 2013 to 2022.
But any number of variables can quickly shift that
calculus, including the price of the home relative to the rent, whether the
family is affluent enough to benefit from tax savings, and the time spent in
the home.
“The longer you stay, the stronger the argument is for
buying, all else equal,” said Aron Szapiro, who conducted the analysis. But he
also contends that the tax advantages of homeownership are often oversold,
particularly to moderate-income households.
If you’re trying to determine the right option, some
guideposts may help. Mr. Szapiro, for example, found that in households with
about $100,000 in earnings, net wealth typically rose more 10 years after
buying a home than if they had rented — but only if the annual rent was 6
percent or more of the purchase price. So it would pay to buy a $600,000 home
when rent in the area was about $3,000 a month or more. (In a couple of places,
including New York and Washington, he found that it made sense to buy when the
cost of renting was a bit lower relative to home prices.)
William Bernstein, an investment adviser who has written
several books for do-it-yourself investors, offered another rule of thumb:
Never pay more than 15 years’ fair rental value for any home, or 180 months of
rent.
Why 15 years? By his calculations, someone paying more
than 180 months of rent might potentially do better by investing in the market,
after considering the costs of owning.
So if an apartment would rent for $4,000 a month, that
means you shouldn’t pay more than $720,000 ($4,000 x 180) for an equivalent
property.
Perhaps easier to digest, Zillow advocates
looking at how long it would take for buyers to break even, when compared with
renters who invested their down payment of 20 percent and any savings in the stock
market. Not surprisingly, buyers in places like Brooklyn, Washington and Los
Angeles had to wait longer, at least four years.
Then there’s what you feel in the pit of your stomach.
To Mr. Austin, house prices in the enclave where he lives in Los Angeles feel
as if they are in a bubble, the housing downturn a faded memory. “Many people
we know,” he added, “are tripping over themselves to buy right now.”
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