rent or buy?

I am often asked whether it is better to rent or to purchase a home. As I am an economist, friends assume that I have an answer. But, precisely because I am an economist, my response is usually “It depends”.

University of Oregon economist Tim Duy has drafted a very useful answer (It depends!) on his blog. I agree with his post, but would like to add a few points that are missing.


First, I shamelessly copy and paste most of Tim’s blog. Then, I add my own points.

Rent or buy? …. From my experience, these are the pros and the cons:

Pros

– You earn the untaxed imputed rent (you pay yourself rent) and receive a tax deduction on your mortgage interest. Double subsidy.

– Assuming a fixed rate mortgage, you no longer face the prospects of future rent hikes.

– Owner-occupied housing provides you both the service of shelter and an investment asset.
It is a leveraged asset, which improves returns in a rising market.

– Mortgage rates are historically low. That won’t last if policymakers do their jobs.

– Housing is a hedge against inflation.

– You receive psychological benefits.

Cons

– It doesn’t provide cash flow. Instead, it requires cash flow. Mortgage payments, property taxes, insurance, repairs, etc.

– Most buyers do not recognize/plan for depreciation costs. I have heard that you should expect annual depreciation of 2% of the cost of your home. This seems consistent with my experience.

– Maintenance and upkeep are time consuming, particularly for single-family housing. Anyone want to come over and rake leaves with me this weekend?

– Depending on the market, it can be an illiquid asset. This can be a problem if you plan/need to move. This is especially the case if you buy in a region that is struggling economically.

– It is a leveraged asset, which is brutal in a falling market.

[…]

My standard advice is that property should be a part of your portfolio, but not your entire portfolio. If buying a home leaves you cash poor or unable to save in your firm’s retirement plan, it probably isn’t a good option for you. If you plan to move soon, it probably isn’t a good option. If you are too busy with your career to deal with upkeep, it probably isn’t a good option. Recognize the risk that comes with the reward. If you aren’t ready to accept the risk, it probably isn’t a good option.

[….]

I have heard the advice that you should buy the most expensive house you can because the burden will fall as your earnings rise. Bad advice, in my opinion. Following this advice will leave you cash poor and unable to meet other financial goals or prepare for a life change or emergency. My advice is to leave substantial margin for error. And buy for the neighborhood, not the house.

[….]

Good luck with whatever decision you make.

Tim Duy, “Rent or Buy?“, Tim Duy’s Fed Watch, 18 November 2016.

Click on the link above to read the full blog and, most importantly, the readers’ comments.

Here are the points that I would add.

First, the imputed benefit is the rent that you would otherwise have to pay to live in the home. But this is the gross benefit. To calculate the net benefit, it is necessary to deduct the interest paid on a mortgage, and the opportunity cost of investing your own savings in the home. (This is whatever you could earn by investing the savings somewhere else.) Additional deductions are property taxes, maintenance, insurance and utilities (such as water) normally paid by the landlord rather than the tenant.

Second, the imputed rent – the NET rent, not the gross – is not taxable as income, so is subsidized. There is an additional subsidy if the mortgage interest can be deducted from taxable income. This is true in the United States, but – to my knowledge – in no other country. Mortgage interest is certainly not deductible in Canada, unless the mortgage is on a property that you rent to others, declaring the income on your tax return.

Third, purchasing a home rather than renting can, for some, be a useful form of forced savings. The goal might be to pay of the entire mortgage before retirement. After retirement, you can live in the home, enjoying the implicit tax-free income of imputed rent, or you can sell the property and move to a smaller home, perhaps in a warmer or more pleasant location. Of course, if you borrow against the equity in your home, home ownership does not encourage savings.

Downsizing on retirement brings me to a final  point. Should a portion of the proceeds from sale of a house be used to purchase a condominium? My advice in this instance is a clear NO. Just a few days ago, I was at a dinner party where one of the guests was a realtor. I was impressed by her honesty. She complained that many self-interested realtors urged older clients, with money from the sale of a large home, to immediately purchase another home. She (correctly in my opinion) thought that it is much better for them to rent an apartment, invest the money in stocks, bonds or other liquid savings, and draw on the funds to add joy and dignity to their lives.

The real estate agent, by the way, is now semi-retired and followed the advice that she gives her clients. She and her husband sold their large home, and are now living in a lovely rental apartment.

See here for another TdJ post on the subject of renting vs buying.

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